<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Mark One
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 1998.
[ ] 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 August 9, 1998, 5,760,235 shares
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION Page No.
- ------------------------------ --------
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 1998 and
December 31, 1997 3
Consolidated Statements of Operations for the Six
Months Ended June 30, 1998 and 1997 4
Consolidated Statements of Operations for the Three
Months Ended June 30, 1998 and 1997 5
Statement of Comprehensive (Loss) Income for the Six
Months Ended June 30, 1998 and 1997 6
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
PART II. - OTHER INFORMATION
- ------------------------------
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
The accompanying notes are an integral part
of the consolicated financial statements.
-2-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, 1998 and December 31, 1997
(Unaudited)
June 30, December 31,
1998 1997
------------ ------------
Assets:
Cash and due from banks $ 11,801,147 $ 6,204,177
Federal funds sold 34,912,591 22,257,266
Interest bearing deposits in financial
institutions 94,939 94,939
Investment securities:
Available-for-sale 42,377,222 28,785,162
Loans 131,379,876 100,846,310
Less: Unearned interest (2,166,223) (2,212,391)
Allowance for credit losses (1,474,720) (950,809)
------------ ------------
Net loans 127,738,933 97,683,110
Medical claims receivables, net 1,074,166 3,073,155
Premises and equipment, net 7,376,268 3,760,550
Accrued interest receivable 1,320,315 908,487
Other real estate and repossessed assets 628,894 158,271
Deferred tax asset 1,877,555 1,622,394
Other assets 2,514,205 2,381,887
Excess of cost over fair value of net
assets acquired, net of accumulated
amortization of $2,550,606 and
$2,377,636 at June 30, 1998 and
December 31, 1997, respectively 9,054,447 4,722,220
------------ ------------
Total assets $240,770,682 $171,651,618
============ ============
Liabilities and shareholders' equity:
Demand deposits $ 38,467,969 $ 22,185,320
Savings, NOW and money markets 62,116,613 44,477,424
Time deposits, $100,000 and over 36,928,716 23,492,179
Other time deposits 81,996,009 64,386,569
------------ ------------
Total deposits 219,509,307 154,541,492
Accrued interest payable and
other liabilities 1,532,040 1,232,793
Convertible subordinated debt 4,350,000
------------ ------------
Total liabilities 225,391,347 155,774,285
------------ ------------
Shareholders' equity:
Preferred stock, $.01 par value,
1,000,000 shares authorized, none
issued at June 30, 1998 and
December 31, 1997 - -
Common stock, $.01 par value,
20,000,000 shares authorized,
5,840,071 and 5,790,171 shares
issued at June 30, 1998 and
December 31, 1997, respectively,
and 5,760,235 and 5,755,882
outstanding at June 30, 1998
and December 31, 1997, respectively 58,401 57,902
Additional paid-in capital 17,031,136 16,867,777
Accumulated deficit (1,534,491) (1,024,435)
Stock rights issuable 57,902 57,902
Treasury stock, 79,836 and 34,289
shares at June 30, 1998 and at
December 31, 1997 carried at cost (255,073) (172,828)
Accumulated other comprehensive income,
net of tax 21,460 91,015
------------ ------------
Total shareholders' equity 15,379,335 15,877,333
------------ ------------
Total liabilities and
shareholders' equity $240,770,682 $171,651,618
============ ============
The accompanying notes are an integral part
of the consolicated financial statements.
-3-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
for the six months ended June 30, 1998 and 1997
(unaudited)
Six Months Ended
June 30, June 30,
1998 1997
---------- ----------
Interest income:
Commercial and real estate loans $3,273,977 $2,305,162
Consumer loans 602,233 656,414
Insurance premium financing 1,935,262 2,459,277
Medical claims receivable factoring 823,721 1,199,275
Federal funds sold 799,355 259,974
Investment securities:
Taxable 946,524 1,130,090
Tax-exempt 128,327 158,505
Interest bearing deposits 2,903 11,219
---------- ----------
Total interest income 8,512,302 8,179,916
---------- ----------
Interest expense:
Savings, NOW and money market 696,860 655,013
Time deposits, $100,000 and over 835,996 539,257
Other time deposits 1,899,254 1,656,051
Other interest expense 100,253 -
---------- ----------
Total interest expense 3,532,363 2,850,321
---------- ----------
Net interest income before
provision for credit losses 4,979,939 5,329,595
---------- ----------
Provision for credit losses on loans 1,611,875 35,000
Net provision for medical claims
receivables losses 26,244 115,000
---------- ----------
Net interest income 3,341,820 5,179,595
---------- ----------
Noninterest income 1,219,239 1,121,775
---------- ----------
Noninterest expense:
Salaries and employee benefits 2,691,256 2,418,248
Occupancy and equipment 945,720 733,744
General and administrative 1,631,576 1,541,050
---------- ----------
Total noninterest expense 5,268,552 4,693,042
---------- ----------
(Loss) income before income taxes (707,493) 1,608,328
Income tax (benefit) expense (255,161) 597,613
---------- ----------
Net (loss) income $ (452,332) $1,010,715
========== ==========
Basic (loss) earnings per share of common stock $ (0.08) $ 0.18
========== ==========
Weighted average shares outstanding 5,758,931 5,750,870
========== ==========
Diluted (loss) earnings per share of common
stock $ (0.08) $ 0.17
========== ==========
Weighted average shares outstanding
And common stock equivalents 5,999,426 5,874,729
========== ==========
The accompanying notes are an integral part
of the consolicated financial statements.
-4-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
for the three months ended June 30, 1998 and 1997
(unaudited)
Three Months Ended
June 30, June 30,
1998 1997
---------- ----------
Interest income:
Commercial and real estate loans $2,089,389 $1,182,649
Consumer loans 329,014 321,688
Insurance premium financing 958,762 1,325,507
Medical claims receivable factoring 285,154 592,950
Federal funds sold 449,153 65,304
Investment securities:
Taxable 593,986 588,040
Tax-exempt 92,257 78,704
Interest bearing deposits 1,471 5,608
---------- ----------
Total interest income 4,799,186 4,160,450
---------- ----------
Interest expense:
Savings, NOW and money market 411,949 352,453
Time deposits, $100,000 and over 516,723 268,430
Other time deposits 1,075,890 829,203
Other interest expense 100,253 -
---------- ----------
Total interest expense 2,104,815 1,450,086
---------- ----------
Net interest income before
provision for credit losses 2,694,371 2,710,364
---------- ----------
Provision for credit losses on loans 1,251,875 35,000
Net provision for medical claims
receivables losses 459,043 40,000
---------- ----------
Net interest income 983,453 2,635,364
---------- ----------
Noninterest income 648,269 555,427
---------- ----------
Noninterest expense:
Salaries and employee benefits 1,494,994 1,225,415
Occupancy and equipment 543,412 375,789
General and administrative 826,136 776,381
---------- ----------
Total noninterest expense 2,864,542 2,377,585
---------- ----------
(Loss) income before income taxes (1,232,820) 813,206
Income tax (benefit) expense (448,142) 302,315
---------- ----------
Net (loss) income $ (784,678) $ 510,891
========== ==========
Basic (loss) earnings per share of common stock $ (0.14) $ 0.09
========== ==========
Weighted average shares outstanding 5,760,502 5,751,882
========== ==========
Diluted (loss) earnings per share of
common stock $ (0.14) $ 0.09
========== ==========
Weighted average shares outstanding
And common stock equivalents 6,007,112 5,875,741
========== ==========
The accompanying notes are an integral part
of the consolicated financial statements.
-5-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
STATEMENT OF COMPREHENSIVE (LOSS) INCOME
for the six months ended June 30, 1998 and 1997
(unaudited)
Six Months Ended
June 30, June 30,
1998 1997
--------- --------
Net (loss) income $(452,332) $1,010,715
Other comprehensive (loss) income,
net of income tax
Unrealized holding (losses) gains (69,555) 9,517
--------- ----------
Comprehensive (loss) income $(521,887) $1,020,232
========= ==========
Disclosure of reclassification amount:
Unrealized holding (losses) gains
arising during period $ (35,206) $ 2,874
Reclassification adjustment for
(losses) gains included in
net (loss) income, net of
income tax (34,349) 6,643
--------- ----------
Net unrealized (losses) gains on securities $ (69,555) $ 9,517
========= ==========
The accompanying notes are an integral part
of the consolicated financial statements.
-6-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 1998 and 1997
(unaudited)
June 30,
-----------------------------
1998 1997
------------ ------------
Cash flows from operating activities:
Net (loss) income $ (452,332) $ 1,010,715
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Net provision for credit losses 1,638,119 150,000
Depreciation 323,229 360,149
Amortization of intangible assets 172,970 227,469
Gain (loss) on sale of available-
for-sale securities 53,670 (10,379)
Loss on sale or disposal of assets 86,278 20,209
Changes in assets and liabilities:
Unearned interest on loans (46,168) (65,710)
Other assets (211,447) (260,908)
Accrued interest payable and
other liabilities (434,252) (683,427)
------------ ------------
Net cash provided by
operating activities 1,130,067 748,118
Cash flows from investing activities:
Net increase (decrease) in loans 2,073,579 (10,661,259)
Payments received on purchased medical
claims receivables 9,081,806 9,606,343
Purchases of medical claims receivables (7,109,061) (12,991,743)
Purchases of available-for-sale securities (12,479,949) (5,973,016)
Proceeds from sales of available-for-sale
securities 4,256,197 2,948,507
Proceeds from maturities of available-
for-sale securities 13,873,260 2,959,236
Proceeds from maturities of held-to-
maturity securities 2,164,507
Proceeds from maturities of interest
bearing deposits in financial
institutions 95,698
Purchases of bank premises and equipment (228,117) (262,524)
Proceeds from sale of other real estate
and repossessed assets 60,715 467,766
Net cash acquired in acquisition 2,956,010
------------ ------------
Net cash provided by (used in)
investing activities 12,484,440 (11,646,485)
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in deposits 206,175 (1,855,413)
Issuance of subordinated debt 4,350,000
Purchase of treasury stock (82,245) (98,289)
Exercise of stock options 163,858 98,289
------------ ------------
Net cash provided by (used in)
financing activities 4,637,788 (1,855,413)
------------ ------------
Net increase (decrease) in cash and cash
equivalents 18,252,295 (12,753,780)
Beginning cash and cash equivalents 28,461,443 22,866,457
------------ ------------
Ending cash and cash equivalents $46,713,738 $10,112,677
============ ============
The accompanying notes are an integral part
of the consolicated financial statements.
-7-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 1998 and 1997
(unaudited)
June 30,
------------------------
1998 1997
----------- --------
Supplemental schedule of noncash investing
and financing activities:
Transfers of repossessed collateral to
other assets $ 147,393 $226,562
Additions to loans to facilitate the sale
of other real estate and other assets $ 3,225 $233,724
Adjustments to other assets subsequent
to acquisition $141,955
Net cash acquired through acquisitions:
Investment securities $19,261,707
Net loans 33,839,277
Premises and equipment, net 3,785,737
Other assets 1,099,583
Excess of cost over fair value of net
assets acquired 4,505,197
Deposits (64,761,640)
Other liabilities (685,871)
-----------
Net cash acquired through acquisitions $(2,956,010)
===========
The accompanying notes are an integral part
of the consolicated financial statements.
-8-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
----------------------
Surety Capital Corporation (the "Company") is a publicly-
traded bank holding company located in Hurst, Texas. The
Company owns a national bank, Surety Bank, National
Association ("Surety Bank"), with full service offices
located in Lufkin, Hurst, Chester, Wells, Kennard,
Whitesboro, Waxahachie, Midlothian, Universal City, Converse,
New Braunfels, San Antonio, and Schertz, Texas. See,
however, "Note 6. Subsequent Events" regarding the pending
sale of the Chester, Kennard, Lufkin and Wells branches.
Surety Bank engages in general commercial and consumer
banking and concentrates its lending activities in the area
of insurance premium financing. 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
necessary to present fairly the financial position of the
Company as of June 30, 1998, 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, 1998.
2. Acquisition:
------------
TexStar National Bank, Universal City, Texas
On April 1, 1998, the Company completed the acquisition of
TexStar National Bank, Universal City, Texas ("TexStar"),
through the merger of TexStar into Surety Bank. With the
completion of this acquisition, Surety Bank increased its
asset size by approximately 41%. As of April 1, 1998,
TexStar had total assets of $70,335,000, and Surety Bank's
total assets as of the same date were $177,818,000. The
acquisition has been accounted for as a purchase in the
accompanying consolidated financial statements. The assets
and liabilities of TexStar have been recorded at their fair
values as of April 1, 1998. The resulting goodwill is being
amortized over 15 years on a straight line basis.
Included in the accompanying consolidated financial
statements are the following amounts for TexStar as of June
30, 1998 and for the three months ended June 30, 1998:
Balance sheet data:
Cash and due from banks $ 4,505,358
Federal funds sold 10,525,000
Investment securities 15,656,019
Net loans 33,938,310
Premises and equipment, net 3,726,542
Accrued interest receivable 427,477
Goodwill 4,521,229
Other assets 502,389
-----------
Total assets $73,802,324
===========
-9-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. Acquisition continued:
-----------
Income statement data:
For the three months
months ended
June 30, 1998
--------------------
Total interest income $ 1,277,502
Total interest expense 581,077
Other income 154,670
Noninterest expense 651,652
------------
Net income $ 112,074
============
The consolidated results of operations include the operations
of TexStar subsequent to April 1, 1998. The unaudited pro
forma information for the six months ended June 30, 1998 and
the unaudited pro forma information for the six months ended
June 30, 1997, presented below, reflect the acquisition of
TexStar as if it had been acquired as of January 1, 1997.
Pro forma adjustments consisting of a provision for income
taxes and interest expense have been made to properly reflect
the unaudited pro forma information.
Six Months Ended
-----------------------------
June 30, 1998 June 30, 1997
------------- -------------
Interest income $10,180,621 $10,456,055
Net (loss) income (1,209,034) 1,284,814
Net (loss) income per share
of common stock $ (0.21) $ 0.22
3. Loans, net:
-----------
At June 30, 1998 and December 31, 1997 the loan portfolio was
composed of the following:
June 30, December 31,
1998 1997
------------ ------------
Insurance premium financing $ 40,368,323 $ 40,373,695
Installment loans 12,529,269 10,632,451
Commercial loans 46,880,433 23,171,566
Real estate loans 31,601,851 26,668,598
------------ ------------
Total gross loans 131,379,876 100,846,310
Unearned interest (2,166,223) (2,212,391)
Allowance for credit losses (1,474,720) (950,809)
------------ ------------
Loans, net $127,738,933 $ 97,683,110
============ ============
Loans on which the accrual of interest has been discontinued
amounted to approximately $1,328,000 and $92,000 at June 30,
1998 and December 31, 1997, respectively.
-10-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
3. Loans, net continued:
----------
Activity in the allowance for credit losses is as follows:
<TABLE>
<CAPTION>
Six Six Three Three
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
1998 1998 1997 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Beginning balance $ 950,809 $1,170,928 $1,067,041 $1,036,601
Provision for credit losses 1,611,875 1,251,875 35,000 35,000
Bank acquisition 820,625 820,625
Loans charged off, net of
recoveries (1,908,589) (1,768,708) (98,063) (67,623)
---------- ---------- ---------- ----------
Ending balance $1,474,720 $1,474,720 $1,003,978 $1,003,978
========== ========== ========== ==========
</TABLE>
4. Medical Claims Receivables:
---------------------------
At June 30, 1998 and December 31, 1997, the medical claims
receivables portfolio was composed of the following:
June 30, December 31,
1998 1997
---------- ------------
Medical claims receivables $1,145,766 $8,079,524
Unearned interest (13,320) (698,484)
Allowance for medical claims
Receivables losses (58,280) (4,307,885)
---------- ------------
Medical claims receivables, net $1,074,166 $3,073,155
========== ============
-11-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. Medical Claims Receivables continued:
--------------------------
Activity in the allowance for medical claims receivables
losses is as follows:
<TABLE>
<CAPTION>
Six Six Three Three
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
1998 1998 1997 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Beginning balance $4,307,885 $4,047,036 $ 217,734 $ 273,382
Provision for credit losses 712,644 775,905 115,000 40,000
Unearned interest
charged off (686,400) (316,862)
---------- ----------
Net provision for credit
losses 26,244 459,043
Receivables charged off,
net of recoveries (4,275,849) (4,447,799) (36,145) (16,793)
---------- ---------- --------- ---------
Ending balance $ 58,280 $ 58,280 $ 296,589 $ 296,589
========== ========== ========= =========
</TABLE>
5. Convertible Subordinated Debt:
------------------------------
Effective March 31, 1998, the Company issued $4,350,000 in 9%
Convertible Subordinated Notes Due 2008 (the "Notes"),
pursuant to an indenture ("Indenture") between the Company
and Harris Trust and Savings Bank, Chicago, Illinois, as
trustee (the "Trustee"). The Notes are general unsecured
obligations of the Company. The terms of the Notes are such
that they should qualify as Tier II capital under the Federal
Reserve Board's regulatory capital guidelines applicable to
bank holding companies. The Notes bear interest at a rate of
9% per annum until maturity. Interest on the Notes is
payable semi-annually on March 31 and September 30 of each
year, commencing September 30, 1998. No principal payments
are due until maturity on March 31, 2008.
The payment of the principal of $4,350,000, premium, if any,
and interest on the Notes are subordinated in right of
payment to the prior payment in full of all senior
indebtedness of the Company. Upon the occurrence of certain
events involving the bankruptcy, insolvency, reorganization,
receivership or similar proceedings of the Company, either
the Trustee or the holders of not less than 25% in aggregate
principal amount of the outstanding Notes may declare the
principal of the Notes, together with any accrued and unpaid
interest, to be immediately due and payable. The Notes do
not otherwise provide for any right of acceleration of the
payment of principal thereof.
Each holder of Notes has the right at any time prior to
maturity of the Notes, unless previously redeemed, at the
holder's option, to convert such Notes, or any portion
thereof which is an integral multiple of $10,000, into shares
of Common Stock of the Company, at the conversion price of
$6.00 per share, subject to certain antidilutive adjustments
(the "Conversion Price").
The Notes are not subject to mandatory redemption or sinking
fund provision. The Notes are redeemable for cash at the
option of the Company on at least 30 but not more than 60
days notice, in whole or in part, at any time after the date
of issuance and on or before March 31, 2002 at the redemption
prices set forth in the table below, plus accrued interest to
the date of redemption, if the closing sales price of the
Common Stock shall be at least 130% of the Conversion Price
then in effect for a period of 20 consecutive trading days in
the principal market in which the Common Stock is then
traded. At any time after March 31, 2002 and prior to
maturity, the Notes are redeemable for cash at the option of
the Company, on at least 30 but not more than 60 days notice,
in whole or in
-12-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
5. Convertible Subordinated Debt continued:
-----------------------------
part, at the redemption prices set forth in the table below,
plus accrued interest to the date of redemption.
If Redeemed During Percentage of If Redeemed During Percentage of
12 Months Ended Principal 12 Months Ended Principal
March 31, Amount March 31, Amount
- ------------------ ------------- ------------------ -------------
1999 109% 2004 104%
2000 108% 2005 103%
2001 107% 2006 102%
2002 106% 2007 101%
2003 105% 2008 100%
6. Subsequent Events:
------------------
On July 20, 1998, the Company announced that Surety Bank
entered into an agreement with Commercial Bank of Texas,
National Association ("Commercial Bank"), Nacogdoches,
Texas, to sell to Commercial Bank Surety Bank's four east
Texas branches located in Lufkin, Kennard, Wells and Chester
(the "Branches").
The purchase price for the Branches will be equal to 4% of
the deposit base of the Branches as of the closing date.
This transaction will be structured as an assumption of
certain liabilities of the Branches, including deposits, and
a purchase of certain assets of the Branches, including
loans and fixed assets, by Commercial Bank.
As of June 30, 1998, the Branches had total deposits of
approximately $56,230,000, total net loans of approximately
$11,892,000 and fixed assets of approximately $647,000.
After the sale is completed, Surety Bank will have
approximately $186,000,000 in assets, and $163,481,000 in
deposits and $123,000,000 in loans. Surety Bank will continue
to operate its remaining nine banking branches, located in
north-central and south-central Texas, as full service community
banking facilities serving the local retail and small business
markets. Surety Bank's operating division, Surety Premium Finance
("Surety Premium"), will continue to market its niche lending
product, insurance premium financing.
The completion of the sale is subject to a number of
contingencies, including regulatory approvals by applicable
banking authorities and a due diligence review of the
Branches by Commercial Bank. There can be no assurance that
the transaction will be completed. If consummated, the
transaction is expected to close no later than December 31,
1998, upon the expiration of all applicable waiting periods
following receipt of all necessary regulatory approvals.
During July 1998, the Office of the Comptroller of the
Currency ("OCC") commenced an examination of Surety Bank.
Upon completion of fieldwork, the OCC made certain
recommendations to management to make additional charge-offs
of insurance premium finance loans and medical claims
factoring receivables and to take additional provisions.
The OCC has not issued a final report of the examination to
management.
-13-
PAGE
<PAGE>
SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. Subsequent Events continued:
-----------------
The charge-offs and additional provisions were recognized in
the six months ended June 30, 1998. The loan charge-offs net
of recoveries for the six months ended June 30, 1998 were
$1,908,589. The loan charge-offs were primarily the result
of insurance premium finance loans generated by Surety
Bank's southeastern United States insurance premium finance
operation, headquartered in Atlanta, Georgia. Due to
significantly higher rates of cancellations and several
problem insurance agency and insurance company relationships,
the Bank's past dues and problem loans originated from that
market had increased significantly in recent months. The Bank
charged-off insurance premium finance loans net of recoveries in
the amount of $1,492,134 for the six months ended June 30, 1998.
No assurance can be given, however, that the Company will not be
required to charge-off additional insurance premium finance loans
in the future. The Atlanta office has been closed and, with exception
of a few good relationships, loan production from that market has
been terminated. Management will continue to actively and
aggressively attempt to collect these charged-off loans.
Surety Bank's traditional Texas insurance premium finance
portfolio continues to perform as expected. Management further
believes that at June 30, 1998 its loan loss reserves are adequate.
However, future events may dictate that additional provisions are
necessary.
The Company recorded a net $26,244 provision for medical
claims factoring losses during the six months ended June 30,
1998 compared to a $115,000 provision for medical claims
factoring losses during the six months ended June 30, 1997.
The medical claims factoring charge-offs net of recoveries
for the six months ended June 30, 1998 were $4,275,849. The
medical claims factored receivables charged off during the
six months ended June 30, 1998 were originated prior to
December 31, 1997. The OCC believed that due to the slower
than expected collection pace of these factoring receivables over
180 days, they should be charged-off in their entirety and
collection should be reflected as recoveries. The current
balance of medical claims factored receivables net of unearned
interest and allowance is at $1,074,166 as of June 30, 1998 and
is not expected to increase. Management is currently evaluating
exit strategy options for the medical claims factoring division
of Surety Bank. Management will continue to actively pursue the
collection of these charged-off receivables.
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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, owns all
of the issued and outstanding shares of capital stock of Surety
Bank.
The information presented below reflects the lending and related
funding business of the Company:
Six Months Six Months
Ended Ended
June 30, 1998 June 30, 1997
------------- -------------
INSURANCE PREMIUM FINANCING:
Average balance outstanding $ 40,800,337 $ 43,587,571
Average yield 9.5% 11.3%
Interest income $ 1,935,262 $ 2,459,277
CONSUMER, COMMERCIAL AND REAL
ESTATE FINANCING:
Average balance outstanding $ 74,678,382 $ 58,626,232
Average yield 10.4% 10.1%
Interest income $ 3,876,210 $ 2,961,576
MEDICAL CLAIMS RECEIVABLES:
Average balance outstanding $ 6,369,385 $ 8,101,948
Average yield 25.9% 29.6%
Interest income $ 823,721 $ 1,199,275
COST OF FUNDS:
Average balance outstanding(1) $189,420,608 $155,179,729
Average interest rate 3.7% 3.7%
Interest expense(1) $ 3,532,363 $ 2,850,321
AVERAGE MONTHLY AMOUNTS:
Total interest income $ 1,496,607 $ 1,363,319
Total interest expense $ 588,727 $ 475,053
Provision for credit losses $ 288,487 $ 5,833
Provision for medical claims
receivables losses $ 62,423 $ 19,167
Noninterest income $ 203,207 $ 186,962
Noninterest expense $ 858,520 $ 782,174
Note: Average balances are computed using daily balances
throughout each period.
The average yields are gross yields and do not include
provisions for credit losses.
(1) Includes $2,175,000 and $0 of borrowings and $100,253 and $0
of interest expense on short-term borrowings for the six
months ended June 30, 1998 and 1997, respectively.
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AVERAGE BALANCE SHEET
Six Months Ended June 30, 1998
----------------------------------
Interest
Average Income/ Average
Balance Expense Rate
------------ ----------- -----
ASSETS:
Interest earnings assets:
U.S. Treasury and agency
securities and due from
time(1) $ 33,469,052 $ 1,077,754 6.4%
Federal funds sold 29,951,573 799,355 5.3%
Loans(2)(3) 115,478,719 5,811,472 10.1%
Medical claims receivables 6,369,385 823,721 25.9%
Allowance for credit losses
and factoring (5,292,868) N/A N/A
------------ ----------- -----
Total interest
earning assets 179,975,861 $ 8,512,302 10.0%
------------ =========== =====
Cash and due from banks 7,285,266
Premises and equipment 5,199,343
Accrued interest receivable 993,506
Other assets 12,588,099
------------
Total assets $206,042,075
============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing liabilities:
Interest bearing demand
deposits $ 43,641,345 $ 581,876 2.7%
Savings deposits 9,445,079 114,984 2.4%
Time deposits 104,220,478 2,735,250 5.3%
Notes payable 2,529,730 100,253 7.9%
------------ ----------- -----
Total interest
bearing liabilities 159,836,632 3,532,363 4.4%
------------ ----------- -----
Net interest income $ 4,979,939
===========
Net interest spread 5.6%
-----
Net interest income to average
earning assets 6.1%
=====
Noninterest bearing deposits 29,583,976
Accrued interest payable and
other liabilities 572,598
------------
Total liabilities 189,993,206
Shareholders' equity 16,048,869
------------
Total liabilities and
shareholders' equity $206,042,075
============
(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.
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Six Months Ended June 30, 1998 Versus Six Months Ended June 30, 1997.
- ---------------------------------------------------------------------
The Company and its wholly-owned subsidiary, Surety Bank, recorded
a net loss of $(452,332) or a net loss per basic common share of
$(0.08) for the six months ended June 30, 1998, compared with
earnings of $1,010,715 ($0.18 per basic common share) for the six
months ended June 30, 1997. The reported loss for the six months
ended June 30, 1998 was primarily the result of an additional
provision for credit losses and a net provision for factoring
losses totaling $1,638,119. These provisions were necessary as a
result of factoring receivables charge-offs of approximately
$1,733,000 and insurance premium finance loan charge-offs of
approximately $526,000 recommended by the Office of the
Comptroller of the Currency ("OCC") in connection with a recent
examination of Surety Bank by the OCC, as more fully disclosed
below.
The yields earned by the Company on its consumer, commercial and
real estate loan portfolio during the six months ended June 30,
1998 and 1997 increased 0.03% to 10.4% from 10.1%, respectively.
The yields earned by the Company on its insurance premium finance
loans during the six months ended June 30, 1998 and 1997 decreased
1.8% to 9.5% from 11.3%. The decrease in yield on the insurance
premium finance loans is attributed to the reversal of interest
income recognized on insurance premium finance loans which were
placed on non-accrual status in the amount of $98,081 (the gross
amount of insurance premium finance loans placed on non-accrual
status at June 30, 1998 was $871,829) along with a decline in the
average balance of insurance premium finance loans outstanding for
the six months ended June 30, 1998 and 1997 in the amount of
$2,787,234 to $40,800,337 from $43,587,571. The average cost of
funds for the Company for the same periods was unchanged at 3.7%.
The average balance of loans outstanding increased 13.0% and was
$115,478,719 and $102,213,803 for the six months ended June 30,
1998 and 1997, respectively. The increase in loans outstanding is
attributed to the acquisition of TexStar on April 1, 1998. The
loan-to-deposit ratio as of June 30, 1998 and 1997 was 59.9% and
70.9%, respectively.
Total interest income increased 4.1% to $8,512,302 from
$8,179,916, for the six months ended June 30, 1998 and 1997,
respectively, while total interest expense increased 23.9% to
$3,532,363 from $2,850,321, for the six months ended June 30, 1998
and 1997, respectively, resulting in a 6.6% decrease in net
interest income before provision for credit losses to $4,979,939
from $5,329,595 for these same periods. The increase in interest
expense for the six months ended June 30, 1998 as compared to the
same period in 1997 in the amount of $682,042 is attributed to the
additional deposits acquired in the acquisition of TexStar and the
interest expense incurred on the subordinated debt of the Company.
The Company's loan growth for the six months ended June 30, 1998
was concentrated within the real estate loan portfolio and the
commercial loan portfolio. Real estate lending increased by 20.8%
to $31,601,851 from $26,152,676, commercial lending increased by
103.2% to $46,880,433 from $23,069,300, consumer lending decreased
by 0.6% to $11,533,975 from $11,601,709, and insurance premium
financing decreased by 16.3% to $40,368,323 from $48,197,899. The
overall net growth in the loan portfolio is attributed to the
acquisition of TexStar. The average volume of consumer,
commercial, and real estate lending increased 27.4%, with an
increase in the average yields on those loans from 10.1% to 10.4%.
The 6.4% decrease in the average volume of insurance premium
financing loans was accompanied by a yield of 9.5% and 11.3% on
those loans for the six months ended June 30, 1998 and 1997,
respectively. The average balance of interest bearing deposits
increased 20.7%, while the average rate paid was 4.4% and 4.3% for
the six months ended June 30, 1998 and 1997, respectively.
The Company recorded a $1,611,875 provision for credit losses on
loans during the six months ended June 30, 1998 compared to a
$35,000 provision for loan losses during the six months ended June
30, 1997. The loan charge-offs net of recoveries for the six
months ended June 30, 1998 were $1,908,589. The loan charge-offs
were primarily the result of insurance premium finance loans
generated by Surety Bank's southeastern United States insurance
premium finance operation, headquartered in Atlanta, Georgia. Due
to significantly higher rates of cancellations and several problem
insurance agency and insurance company relationships. Surety Bank's past
dues and problem loans originated from that market had increased
significantly in recent months. Surety Bank charged-off insurance
premium finance loans net of recoveries in the amount of
$1,492,134 for the six months ended June 30, 1998. No assurance can
be given, however, that the Company will not be required to charge off
additional insurance premium finance loans in the future. The Atlanta
office has been closed and, with exception of a few good
relationships, loan production from that market has been
terminated. Management will continue to actively and aggressively
attempt to collect these charged-off loans. Surety Bank's
traditional Texas insurance premium finance portfolio continues to
perform as expected. Management further believes that at June 30, 1998
its loan loss reserves are adequate. However, future events may dictate
that additional provisions are necessary.
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The Company recorded a $26,244 provision for medical claims
factoring losses during the six months ended June 30, 1998
compared to a $115,000 provision for medical claims factoring
losses during the six months ended June 30, 1997. The medical
claims factoring charge-offs net of recoveries for the six months
ended June 30, 1998 were $4,275,849. The medical claims factored
receivables charged off during the six months ended June 30, 1998
were originated prior to December 31, 1997. The OCC believed that
due to the slower than expected collection pace of these
receivables over 180 days, they should be charged-off in their
entirety and collection should be reflected as recoveries. The
current balance of medical claims factored receivables net of
unearned interest and allowance is at $1,074,166 as of June 30,
1998 and is not expected to increase. Management is currently
evaluating exit strategy options for the medical claims factoring
division of Surety Bank. Management will continue to actively
pursue the collection of these charged-off receivables.
The Company's noninterest income increased 8.7% to $1,219,239 from
$1,121,775 for the six months ended June 30, 1998 and 1997,
respectively. This increase compares to an increase in average
noninterest bearing deposits of 32.1% to $29,583,976 from
$22,399,587 for these same periods. Noninterest income is
generated primarily from fees associated with noninterest and
interest bearing accounts along with fees charged on insurance
premium finance loans.
Noninterest expense increased 12.3%, primarily the result of a
11.3% increase in salaries and employee benefits, a 28.9% increase
in occupancy and equipment expenses, and a 5.9% increase in
general and administrative expenses. The increase in salaries and
benefits was due primarily to additional staffing required by the
acquisition of TexStar. Increases in occupancy and equipment
expenses relate primarily to the operation of the five additional
branches added through the TexStar acquisition.
Three Months Ended June 30, 1998 Versus Three Months Ended June 30, 1997
- ------------------------------------------------------------------------
The Company recorded a net loss of $(784,678) or a net loss per
basic common share of $(0.14) for the three months ended June 30,
1998, compared with earnings of $510,891 ($0.09 per basic common
share) for the three months ended June 30, 1997. Total interest
income increased 15.4% to $4,799,186 from $4,160,450, while total
interest expense increased 45.2% to $2,104,815 from $1,450,086,
resulting in a 0.6% decrease in net interest income before
provision for losses to $2,694,371 from $2,710,364.
The Company recorded a $1,251,875 provision for credit losses on
loans during the six months ended June 30, 1998 compared to a
$35,000 provision for loan losses during the six months ended June
30, 1997. The substantial increase in provisions for the six
months ended June 30, 1998 was a result of a recommendation made
the OCC in connection with its recent examination of Surety Bank.
The loan charge-offs were primarily the result of insurance
premium finance loans generated by Surety Bank's southeastern
United States insurance premium finance operation, headquartered
in Atlanta, Georgia. Due to significantly higher rates of
cancellations and several problem insurance agency and insurance
company relationships, the Bank's past dues and problem loans originated
from that market had increased significantly in recent months. The Atlanta
office has been closed and, with exception of a few good relationships,
loan production from that market has been terminated. Management
will continue to actively and aggressively attempt to collect
these charged-off loans. Surety Bank's traditional Texas
insurance premium finance portfolio continues to perform as
expected.
The Company recorded a net $459,043 provision for medical claims
factoring losses during the three months ended June 30, 1998
compared to a $40,000 provision for medical claims factoring
losses during the three months ended June 30, 1997. The increase
in provisions for the six months ended June 30, 1998 was also a
result of a recommendation made by the OCC in connection with its
recent examination of Surety Bank. The OCC believed that due to
the slower than expected collection pace of these factoring
receivables over 180 days, they should be charged-off in their
entirety and collection should be reflected as recoveries.
Management is currently evaluating exit strategy options for the
medical claims factoring division of Surety Bank. Management will
continue to actively pursue the collection of these charged-off
receivables.
The Company's noninterest income increased 16.7% to $648,269 from
$555,427 for the three months ended June 30, 1998 and 1997,
respectively. Noninterest expense increased 20.5%, primarily the
result of a 22.0% increase in salaries and employee benefits, a
44.6% increase in occupancy and equipment expenses, and a 6.4%
increase in general and administrative expenses. The increase in
salaries and benefits along with occupancy and equipment expenses
were due primarily to additional staffing required by the
acquisition of TexStar.
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<PAGE>
Allowance for Credit Losses
The Company recorded a $1,611,875 provision for credit losses on
loans during the six months ended June 30, 1998 compared to a
$35,000 provision for loan losses during the six months ended June
30, 1997. The substantial increase in provisions for the six
months ended June 30, 1998 was a result of a decision by the
Company's management to accept recommendations made by the OCC in
connection with its recent examination of Surety Bank. The loan
charge-offs net of recoveries for the six months ended June 30,
1998 were $1,908,589. The loan charge-offs were primarily the
result of insurance premium finance loans generated by Surety
Bank's southeastern United States insurance premium finance
operation, headquartered in Atlanta, Georgia. Due to significantly
higher rates of cancellations and several problem insurance agency and
insurance company relationships, the Bank's past dues and problem loans
originated from that market had increased significantly in recent months.
The Bank charged-off insurance premium finance loans net of
recoveries in the amount of $1,492,134 for the six months ended
June 30, 1998. The Atlanta office has been closed and, with
exception of a few good relationships, loan production from that
market has been terminated. Management will continue to actively
and aggressively attempt to collect these charged-off loans.
Surety Bank's traditional Texas insurance premium finance
portfolio continues to perform well. Management believes that all
known losses in the portfolio have been recognized.
The Company recorded a net $26,244 provision for medical claims
factoring losses during the six months ended June 30, 1998
compared to a $115,000 provision for medical claims factoring
losses during the six months ended June 30, 1997. The increase in
provisions for the six months ended June 30, 1998 was a result of
a decision by the Company's management to accept recommendations
made by the OCC in connection with its recent examination of
Surety Bank. The medical claims factoring charge-offs net of
recoveries for the six months ended June 30, 1998 were $4,275,849.
The medical claims factored receivables charged off during the
six months ended June 30, 1998 were originated before December 31,
1997. The OCC recommended that due to the slower than expected
collection pace of these factoring receivables, the
receivables should be charged-off in their entirety and collection
should be reflected as recoveries. The current balance of medical
claims factored receivables net of unearned interest and allowance
is at $1,074,166 as of June 30, 1998 and is not expected to
increase. Management is currently evaluating exit strategy
options for the medical claims factoring division of Surety Bank.
Management will continue to actively pursue the collection of
these charged-off receivables. Management believes that all known
losses in the portfolio have been recognized.
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 the allowance for credit losses to total loans was
1.1% on June 30, 1998 as compared to 0.9% on December 31, 1997.
The allowance for credit losses was $1,474,720 and $950,809 on
June 30, 1998 and December 31, 1997, respectively. At June 30,
1998, nonaccrual loans were approximately $1,328,000, loans past
due 90 days or greater and still accruing interest were $67,126,
and total non-performing loans were approximately $2,030,000.
The allowance for medical claims receivables losses to total
medical claims receivables was 5.2% at June 30, 1998 as compared
to 53.3% on December 31, 1997. The allowance for medical claims
receivables losses was $58,280 and $4,307,885 on June 30, 1998 and
December 31, 1997, respectively.
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 minimized its own separate business
activities. For the six months ended June 30, 1998, the Company
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had only nominal interest income of approximately $13,000,
approximately $98,000 in interest expense on its subordinated debt
and approximately $90,000 in noninterest expenses. The
noninterest expenses, which decreased 25.3% 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.
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 June 30, 1998, 16.8% 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. The payment of dividends by Surety Bank is subject
to the provisions of 12 U.S.C. Section 60, which provides that no
dividend may be declared or paid without the prior approval of the
OCC if the total of all dividends, including the proposed
dividend, in any calendar year exceeds the total of Surety Bank's
net profits for that year combined with its retained profits of
the preceding two years. Surety Bank incurred an accumulated loss
for the six months ended June 30, 1998 and for fiscal years 1997
and 1996 in the amount of $2,155,493. Under 12 U.S.C. Section 60,
Surety Bank currently is precluded from declaring a dividend,
without the prior approval of the OCC, until it has profits in
excess of $2,824,677. No assurance can be given if and when
Surety Bank will attain the requisite level of profitability,
which will permit it to declare and pay dividends.
Capital Resources
Shareholders' equity at June 30, 1998 was $15,379,335 as compared
to $15,877,333 at December 31, 1997. The Company had consolidated
net loss of $(452,332) for the six months ended June 30, 1998.
Under the regulatory risk-based capital framework, Surety Bank is
required 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 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 7.07% and 8.13%,
respectively, at June 30, 1998 and 9.92% and 11.28%, respectively,
at December 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.
In connection with the acquisition of TexStar by the Company through
the merger of TexStar with Surety Bank (the "Merger"), the OCC
conditionally approved the Merger, contingent upon (1) the Company
contributing at least $4,000,000 in additional capital to Surety
Bank, (2) Surety Bank maintaining certain OCC-mandated capital
ratios in excess of the minimum "well-capitalized" capital ratios
for the years ending December 31, 1998, 1999 and 2000, and (3) in
the event of the failure of Surety Bank to maintain such minimum
capital ratios, the Company initiating efforts to bring Surety Bank
back into compliance with such minimum capital ratios. On March 31,
1998 the Company contributed $4,000,000 in additional capital to
Surety Bank and on June 30, 1998 the Company contributed $500,000 in
additional capital to Surety Bank. At June 30, 1998, Surety Bank
was not in compliance with the OCC-mandated capital ratio levels.
No assurance can be given that Surety Bank will attain compliance
with the OCC-mandated capital ratio levels by December 31, 1998 and
remain in compliance with such OCC-mandated capital ratio levels on
December 31, 1999 and 2000. If Surety Bank fails to maintain such
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OCC-mandated capital levels for the years ending December 31, 1998,
1999 and 2000, the Company is required (1) to contribute additional
capital to Surety Bank, which, if necessary, may be obtained by the
Company through a traditional loan from a financial institution or
through an offering of the Company's securities, or (2) to liquidate
some of the assets of Surety Bank. On July 13, 1998 Surety Bank
entered into an agreement with Commercial Bank of Texas, National
Association ("Commercial Bank"), Nacogdoches, Texas, to sell to
Commercial Bank Surety Bank's four east Texas branches located in
Chester, Kennard, Lufkin and Wells (the "Branches"). See "Note 6.
Subsequent Events." In the event of the consummation of the sale of
such Branches, the Company believes that Surety Bank will be well
above the OCC mandated capital requirements for the years ending
December 31, 1998, 1999 and 2000, absent the occurrence of any
unforeseeable events. In the event Surety Bank fails to maintain
such OCC-mandated imposition of restrictions on certain activities
involving asset growth, acquisitions, branch establishment,
expansion into new lines of business, declaration and payment of
dividends, and transactions with affiliates, (2) the imposition of
certain additional mandated capital raising activities, and (3) as a
last resort, the appointment of a receiver or conservator of Surety
Bank.
While the Company believes it has sufficient financing for its
working capital needs until the end of its 1998 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 stockholders. 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.
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 stockholders.
Recent Accounting Pronouncements
In June 1997, FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses,
gains, and losses) in a full set of general-purpose financial
statements. SFAS 130 requires that all items that are required to
be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
SFAS 130 does not require a specific format for the financial
statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that
financial statement. SFAS 130 is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes
is required. The Company adopted SFAS 130 in the fiscal quarter
ended March 31, 1998.
In June 1997, FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for the way that public enterprises report information
about operating segments in annual financial statements, and
requires that those enterprises report information about operating
segments in annual financial statements and report selected
information about operating segments in interim financial reports
issued to shareholders. SFAS 131 also establishes standards for
related disclosures about products and services, geographic areas,
and major customers.
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SFAS 131 requires that a public business enterprise report
financial and descriptive information about its reportable
operating segments. Operating segments are components of an
enterprise about which separate financial information is available
that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing
performance. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating
segment performance and deciding how to allocate resources to
segments.
SFAS 131 is effective for fiscal years beginning after December
15, 1997. In the initial year of application, comparative
information for earlier years is to be restated. SFAS 131 will be
adopted by the Company on December 31, 1998. The Company is
expected to have two operating segments to report on, the
traditional banking segment and the insurance premium finance
segment.
In June 1998, FASB issued Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities ("SFAS 133"). SFAS 133 establishes accounting
and reporting standards for derivative instruments and hedging
activities. It requires recognition of all derivatives as either
assets or liabilities in the statement of financial condition and
measurement of those instruments at fair value. The accounting for
gains and losses on derivatives depends on the intended use of the
derivative. This Statement is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999, with earlier
application encouraged. Retroactive application is not permitted.
Management has not completed its evaluation of the expected
impact of SFAS 133 on the financial condition or operations of the
Company.
Management believes that the adoption of these pronouncements will
not have a material impact on the financial condition or results
of operations of the Company.
Year 2000 Safety and Soundness
Year 2000 guidance on the risks posed to financial institutions by
the Year 2000 problem was issued by the Federal Financial
Institutions Examination Council ("FFIEC"). The guidance
underscores that Year 2000 preparation is not only an information
systems issue, according to the FFIEC, but also an enterprise-wide
challenge that must be addressed at the highest level of a
financial institution.
The guidance sets out the responsibilities of senior management
and boards of directors in managing their Year 2000 projects.
Among the responsibilities of institution managers and directors
is that of managing the internal and external risks presented by
providers of data-processing products and services, business
partners, counterparties, major loan customers, correspondent
banks, and institutions or entities in which Surety Bank owns
securities.
Under the guidance, senior management must provide the board of
directors with status reports, at least quarterly, on efforts to
reach Year 2000 goals both internally and by the institution's
major vendors. Senior management and directors must allocate
sufficient resources to ensure that high priority is given to
seeing that remediation plans are fulfilled, and that the project
receives the quality personnel and timely support it requires.
A Year 2000 management committee has been formed by the Company to
identify potential problems associated with the turn of the
century and to develop resolutions to these problems. Renovation
activities such as hardware and software upgrades, system
replacements, and vendor certifications are anticipated to be
completed by the fourth quarter of 1998. Current costs and
estimated future expenditures do not appear to be material and are
expected to have negligible effects on the Company's results of
operations, liquidity and capital resources.
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
-22-
PAGE
<PAGE>
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
Surety 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 Surety 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%).
Forward-Looking Statements
All statements other than statements of historical fact regarding the
Company's financial condition, results of operation, business
strategy and future acquisitions or operations are "forward-looking
statements." When used herein, words such as "believes," "antici-
pates," "intends," "expects," "should," and words of similar import
identify a forward-looking statement. Such forward-looking state-
ments may involve numerous assumptions about known and unknown
trends, risks and uncertainties, including economic conditions;
actions taken by the Federal Reserve Board; legislative and
regulatory actions and reforms; as well as other reasons, all of
which change over time and which may ultimately prove to be
inaccurate. Certain of these factors are discussed in more detail
elsewhere herein. These factors include the Company's ability to
successfully redeploy excess liquidity following the acquisition of
TexStar as well as the Company's ability to continue to make future
acquisitions, as well as the Company's ability to collect charged-off
and provisioned for insurance premium financing loans and medical claims
factoring receivables, and the results of the OCC's recent examination of
Surety Bank. Actual results may differ materially from any future
results expressed or implied by such forward-looking statements.
Prospective investors are cautioned not to place undue reliance on
such forward-looking statements. The Company disclaims any obligation
to update or to publicly revise any of the forward-looking statements
contained herein to reflect future events or developments.
-23-
PAGE
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
Surety Bank (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 Commis-
sioner 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 policyholders, 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. After appeal by Tennessee, the Texas Supreme
court affirmed the judgement of the Court of Appeals.
Tennessee has filed a Motion for Rehearing, which is
currently pending.
On July 27, 1998 the United States District Court in the
Anchorage case granted a summary judgement in favor of the Bank
that Tennessee take nothing by its suit. This judgement has
recently been entered, and it is expected that Tennessee will
appeal to the United States Court of Appeals.
The Bank believes both of these cases lack merit and will
continue to defend them vigorously. The final outcome of both
of these cases is uncertain at this time.
Item 2. Changes in Securities and Use of Proceeds.
Not applicable.
-24-
PAGE
<PAGE>
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on
May 21, 1998. The stockholders voted on the following
matters: (1) an amendment to the Company's Certificate of
Incorporation to increase the authorized shares of Common
Stock from 20,000,000 shares to 40,000,000; (2) the election
of nine directors of the Company; (3) the ratification of the
adoption of the 1998 Incentive Stock Option Plan; and (4) the
appointment of PricewaterhouseCoopers LLP (formerly Coopers &
Lybrand L.L.P.) as the independent public accountants of the
Company for the fiscal year ending December 31, 1998.
The results of the voting for the approval of the increase in
the number of authorized shares of Common Stock was as
follows:
For Against Abstain Broker Non-votes
2,646,791 888,739 19,145 1,533,650
The results of the voting for the election of directors was as
follows:
Name of Nominee For Withheld Abstain
- --------------- --------- -------- -------
C. Jack Bean 4,971,606 34,257 82,462
William B. Byrd 4,971,666 34,197 82,462
Bobby W. Hackler 4,983,606 22,257 82,462
Joseph S. Hardin 4,937,566 68,297 82,462
G. M. Heinzelmann, III 4,983,544 22,319 82,462
Margaret E. Holland 4,983,666 22,197 82,462
Michael L. Milam 4,983,666 22,197 82,462
Garrett Morris 4,937,566 68,297 82,462
Cullen W. Turner 4,983,666 22,197 82,462
The results of the voting for the ratification of the adoption
of the 1998 Incentive Stock Option Plan were as follows:
For Against Abstain Broker Non-votes
2,474,831 1,056,519 23,325 1,533,650
The results of the voting for the appointment of
PricewaterhouseCoopers LLP were as follows:
For Against Abstain Broker Non-votes
5,068,838 9,937 9,550 0
The Amendment to the Company's Certificate of Incorporation
was not approved; all other proposals were approved by the
vote of the stockholders.
-25-
PAGE
<PAGE>
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
On April 9, 1998 the Company filed a Current Report on Form 8-K
to report that effective April 1, 1998 the Company acquired
TexStar National Bank, a national banking association located in
Universal City, Texas with branches in Converse, New Braunfels,
San Antonio and Schertz, Texas. The main office and branches of
TexStar are being operated as branches of Surety Bank.
On May 19, 1998 the Company filed a Current Report on Form 8-K/A
(Amendment No. 1) to amend the Form 8-K filed on April 9, 1998
to include (1) the report of Burnside & Rishebarger, PLLC, dated
January 23, 1998, on its audits of the financial statements of
TexStar National Bank, San Antonio, Texas as of December 31,
1997 and 1996, and for the two years ended December 31, 1997,
and (2) the related pro forma balance sheet as of March 31,
1998, and pro forma income statements for the three months ended
March 31, 1998 and for the twelve months ended December 31, 1997
giving effect to the TexStar purchase.
On May 20, 1998 the Company filed a Current Report on Form 8-K/A
(Amendment No. 2) to make certain revisions to the financial
statements filed with the Current Report on Form 8-K/A
(Amendment No. 1) on May 19, 1998.
On June 2, 1998 the Company filed a Current Report on Form 8-K
to report that at the Company's annual meeting of stockholders
held on May 21, 1998 C. Jack Bean announced that he will retire
as Chairman of the Board and Chief Executive Officer of the
Company and as Chairman of the Board of the Company's
subsidiary, Surety Bank, National Association ("Surety Bank"),
effective as of August 31, 1998. Bobby W. Hackler has been
named to succeed Mr. Bean as Chairman of the Board and Chief
Executive Officer of the Company and as Chairman of the Board of
Surety Bank, effective upon Mr. Bean's retirement. Mr. Hackler
will continue to serve as the President and Chief Executive
Officer of Surety Bank, and as a director of both the Company
and Surety Bank.
On July 27, 1998 the Company filed a Current Report on Form 8-
K to report that on July 13, 1998 Surety Bank entered into a
Branch Purchase and Assumption Agreement with Commercial Bank
of Texas, National Association, Nacogdoches, Texas, to sell to
Commercial Bank the Bank's four east Texas branches located in
Lufkin, Kennard, Wells and Chester.
-26-
PAGE
<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: August 19, 1998 SURETY CAPITAL CORPORATION
By: /s/ Bobby W. Hackler
--------------------
Bobby W. Hackler
Vice Chairman of the
Board
By: /s/ B.J. Curley
---------------
B.J. Curley
Vice President, Chief
Financial Officer
and Secretary
-27-
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 11,801,147
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