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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(MARK ONE)
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1998
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITIONAL PERIOD
FROM TO
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Commission File Number: 0-15624
SECOND BANCORP, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
OHIO
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(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
108 Main Avenue SW, Warren, Ohio
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
34-1547453
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(I.R.S. EMPLOYER
IDENTIFICATION NO.)
44481
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(ZIP CODE)
Registrant's telephone number, including area code:
(330) 841-0123
Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class
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None
Name of each exchange on which registered
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None
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, no par value
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(Title of Class)
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 periods 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements,
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the Common Stock held by non-affiliates of
the registrant as of March 15, 1999 as reported on the Nasdaq National Market
System, was approximately $215,092,275. Shares of Common Stock held by each
officer and director and by each person who owns 5% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 15, 1999, the registrant had outstanding 10,688,450 of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual shareholders' meeting to be held
on May 11, 1999 are incorporated by reference into Part III.
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FORWARD-LOOKING STATEMENTS
When used in this filing and in future filings by the Corporation with the
Securities and Exchange Commission, in the Corporation's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases, "anticipate,"
"would be," "will allow," "intends to," "will likely result," "are expected to,"
"will continue," "is anticipated," "estimated," "project," or similar
expressions are intended to identify, "forward looking statements" with the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
are subject to risks and uncertainties, including but not limited to changes in
economic conditions in the Corporation's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Corporation's market area, and competition, all or some of which could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected.
The Corporation wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
advise readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investing activities, and competitive and regulatory
factors, could affect the Corporation's financial performance and could cause
the Corporation's actual results for future periods to differ materially from
those anticipated or projected.
The Corporation does not undertake, and specifically disclaims any
obligation, to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
PART I
ITEM 1. BUSINESS
GENERAL
Second Bancorp, Incorporated, ("Second Bancorp") is a one-bank holding
company which owns The Second National Bank of Warren ("Second National"), a
Warren, Ohio based commercial bank. Operating through thirty-three branches and
one loan production office, Second National offers a wide range of commercial
and consumer banking and trust services primarily to business and individual
customers in various communities in an eight county area in northeastern Ohio.
At December 31, 1998, Second Bancorp had consolidated total assets of $1.43
billion, deposits of $1.103 billion and shareholders' equity of $123 million.
Second National focuses its marketing efforts primarily on local
independent commercial and professional firms, the individuals who are the
owners and principals of such firms as well as the low-to-moderate to upper
income retail customers in Second National's trade areas. In recent years,
Second Bancorp has emphasized increased commercial and direct consumer and real
estate lending and market area expansion. Second National has de-emphasized its
previous focus on indirect consumer loan lending through local automobile
dealers.
1998
Second National Bank continued to enhance its position of leadership in the
financial services marketplace during 1998. Each of the year's management
initiatives was designed to help Second National become increasingly valued by
its stakeholders.
GROWTH
The growth of Second National's branch network during 1998 represents a
major milestone for the Bank and Second Bancorp, Inc. This year's de novo
offices and merger and acquisition activity propelled Second National Bank to
$1.43 billion in assets and deposits of $1.1 billion. By year-end 1998, the
Second National branch network grew to 34 offices in seven Ohio counties.
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Acquisitions
Second Bancorp, Inc. announced two separate merger agreements in the spring
of 1998. Both transactions are consistent with Second National's stated growth
plan to become a leader in regional community banking. On April 1, 1998, Second
Bancorp entered into a definitive agreement resulting in the merger of Enfin,
Inc. into Second Bancorp. Following the merger on August 21, Enfin's banking
subsidiary, the $43.7 million Enterprise Bank in Solon, became a Second National
Bank branch. In addition to combining the traditional commercial lending
strengths of both companies, the consolidation marked Second National Bank's
entry into the Solon market, an area that supports thriving business activities
throughout Cuyahoga County.
On May 4, 1998, Second Bancorp, Inc. and Trumbull Financial Corporation
jointly announced the signing of a definitive agreement for the acquisition of
Trumbull Financial by Second Bancorp. On November 20, 1998, Trumbull Financial's
wholly owned subsidiary, the $462 million Trumbull Savings and Loan Company, was
merged into Second National Bank. Like the Second National Bank and Western
Reserve National Bank merger of 1927, Second National's acquisition of Trumbull
Savings was this year's largest financial transaction in the Mahoning Valley.
The merger established Second National as the largest independent bank in the
Mahoning Valley as well as one of its largest employers.
New Branches
In August, Second National opened a new office in Medina, marking the
Bank's entry into yet another Ohio county. From its downtown location, the 1,500
square-foot Medina office will build on an existing customer base and will serve
individual, business, and municipal customers in Medina and nearby Summit
County. The Medina office is staffed by personal bankers, a branch banking
officer, and a commercial lending officer, all providing Second National's brand
of highly personalized, decentralized service. A walk-up ATM, night depository,
and ample parking are available to Medina customers.
The newly constructed Ravenna office opened in March 1998 with a full month
of grand opening activities. The new office, located in a well-traveled portion
of downtown, significantly improved the services and conveniences Second
National provides in Ravenna by offering two drive-thru lanes, a drive-up ATM,
safe deposit boxes, a night depository, and ample parking. With 3,000 square
feet of space, a complete range of products and services, and a specialized
staff of banking professionals, the new Ravenna office is positioned to be a
major competitor in the Portage County market.
TECHNOLOGY
Document Preparation System
Second National developed its own document preparation system for deposit
accounts to reduce the paperwork and time associated with opening an account.
"Maxsys," the new document preparation system, allows branch personnel to input
customer and product information once, then print all necessary cards and forms.
The internally produced software, which reduced the time required to open a new
deposit account from 35 minutes to 5 minutes, also provided a significant
savings to the Bank.
Check Imaging
Second National's conversion to check imaging established the Bank as a
leader in the new technology: only 1,600 -- or 20 percent of -- U.S. banks
currently offer this service to their customers. With check imaging, customers
receive a statement featuring digital images of canceled checks, instead of
their actual checks. Not only are image statements a better way for customers to
review checking activity, the new technology will result in greater efficiencies
and cost savings for the Bank.
Branch Teller System
A new branch teller system installed during 1998 makes more features and
functions available to branch personnel, while increasing data processing
efficiencies and meeting all Y2K compliance requirements. The new system brings
a host of advantages to the Bank, including faster processing and better
customer service.
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Relationship Management System (RMS)
The Relationship Management System (RMS), an enhanced ALLTEL Horizon core
application, replaced and represents a significant improvement over the Bank's
Central Information File (CIF). Using this fully functional relational database,
Second National staff can instantaneously capture a comprehensive picture of any
Second National customer -- complete with details of their account
relationships. In addition to significantly enhancing the Bank's ability to
cross-sell, RMS enables management to analyze and evaluate customer account
relationships.
Report Imaging
Instead of printing hundreds of daily Horizon reports, all management
reports are now accessible through CD-ROM. By migrating from printed reports to
report imaging, Second National will recognize significant savings and recoup
all project costs within the first eight months of operation.
Wide Area Network
A wide area network installed during 1998 increased efficiencies in the
management of the Bank's network communications. By connecting individual
branches directly to the AS 400, the network allows transactions to be handled
more efficiently while minimizing down time.
DELIVERY
24-Hour Call Center
With the addition of an interactive voice response (IVR) system in 1998,
Second National Bank offers an alternative delivery system for customers who
find it more convenient to bank by phone. Through this new delivery channel,
Second National customers are able to do virtually anything they can do in a
branch -- all via a touch-tone telephone. A bill payment option (available March
1999) will allow customers to pay any bill electronically through the IVR.
In tandem with the IVR, the Bank's Customer Information Center was
redesigned into a telephone banking center staffed with personal bankers. The
Call Center provides high-level, personalized account service and allows
customers to open deposit accounts and apply for loans over the telephone.
ATMs
To enhance customer service and convenience, Second National expanded its
network of automated teller machines by installing 11 additional ATMs. Coupled
with eight machines in newly acquired offices, this initiative brought the total
number of ATMs in the network to 34, and made ATM transactions at the Bank's
terminals totally free for Second National MAC(R) ATM cardholders.
PEOPLE
Second National continued its efforts to keep the Bank's core values
foremost in the minds of employees and to inspire its workforce to a high level
of performance. Peer-driven recognition programs remained an important means of
providing Second National employees with the opportunity to define and recognize
excellence in their co-workers. During the "How Far Will Core Values Take You?"
contest of 1998, employees identified more than 10,000 examples of outstanding
performance by their co-workers, and three top employees were rewarded with
trips to Walt Disney World in Orlando, Florida.
Brand
A new marketing communications program, which effectively promoted the
Second National value philosophy in the marketplace, put the spotlight on the
Bank's employees. The advertising campaign and positioning statement, "The
People Making Banking Better," emphasized the quality of Second National
employees and the value they bring to customers. As part of the year's cohesive
marketing efforts, Second
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National Bank's corporate identity was also rejuvenated in 1998. The redesigned
logo and corporate colors, which now appear on all signage and communication,
preserved the equity of the Second National mark while giving the Bank visual
prominence in the marketplace.
LEADERSHIP
Small Business Lending
Second National Bank was again ranked among the area's top small business
lenders by the U.S. Small Business Administration (SBA). During the SBA's fiscal
year 1998, Second National was the top community bank lender in the Cleveland
district and third among district-wide lenders, ahead of several major financial
institutions.
Trust Division
With innovative programs, expert money management, and outstanding customer
service, the Trust Division continued to make a solid contribution to the
success of Second National Bank.
Once again, Second National ranked among the top money managers in the
country, based on investment returns as of the end of 1998. The Trust Division's
equity pension and profit sharing fund and fixed income pension and profit
sharing fund were both nationally ranked for one- and 10-year returns. 1998
annualized returns were 37.81 percent for the equity fund and 15.34 percent for
the fixed income fund. (Rankings were computed by Nelson's Investment Manager
Database, which evaluates 4,000 investment products from more than 1,500
investment management firms and regularly publishes its results in the World's
Best Money Managers.)
In addition to achieving record levels of trust revenue and asset size, the
Trust Division continued to expand its successful Institutional Trust Program,
which provides trust services to other financial institutions and great
potential for future growth.
PRODUCT DEVELOPMENT
ELITE Investment Account
Introduced in 1998, the ELITE Investment Account combines high-yield
investing with the convenience of ATM and checkbook access. The new product
serves as a valuable relationship-builder on the Bank's menu of products and
services. With a high yield, checking privileges, and total liquidity, ELITE was
designed to help Second National compete with other financial institutions in
the marketplace, especially brokerage firms.
Advantage Plus
As part of the Bank's effort to offer customers greater value, it was
determined that the target market for the Advantage Plus Program could be
expanded by developing a true partnership with baby boomers. The age requirement
for this popular package of benefits was reduced from 60 to 50 years old.
COMMUNITY
Second National continued to put an educational focus on its efforts in the
community, underwriting an appearance by activist, author, and media commentator
Tavis Smiley at the annual convocation of the Warren City Schools in the summer
of 1998. Mr. Smiley, the host of "BET Tonight with Tavis Smiley" on Black
Entertainment Television, was invited to Warren to address 700 staff members and
members of the community.
The Bank also offered special programs such as "The ABCs of Funding for New
and Small Businesses" for Warren-area business owners and aspiring
entrepreneurs, and "Fellowship Together for Banking Education," a free program
for the public featuring Second National Bank professionals. Other ongoing
activities included the Entrepreneurship Program, the INROADS Career Development
Program, and the Second National Bank Scholarship Fund.
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1999
To sustain its continuous improvement and increased stakeholder value,
Second National Bank is committed to improving return on assets and its
efficiency ratio, and to increasing deposits and loans during 1999. To
accomplish these goals, Second National has recommitted to an organization-wide
focus on customer relationships and sales performance and will undertake various
projects to enhance profitability, efficiency, and market share.
Sales Performance
To raise the bar on Second National's sales performance, all employees in
the Bank's sales divisions and branches have been challenged to increase the
sale of profitable products to their existing customers. Throughout the year,
sales employees will execute personal business plans designed expressly to
expand the Bank's single account relationships.
Profitability Analysis
Providing quality products and services that meet customer needs and
wants -- at a fair price and profit -- will further leverage Second National
Bank's value advantage. To increase Second National's profitability analysis
capabilities, the Bank will implement three software modules in 1999:
Profitvision (FTI), Asset and Liability Management (Sendero), and the Executive
Information System (FTI).
Profitvision assists in analyzing the Bank's profitability at multiple
levels and from various viewpoints. The application will serve as an integrated
solution to customer, relationship, product, and organization profitability
management. The Asset and Liability Management module is a modeling system that
will serve as an integrated solution to financial and accounting management for
profit planning and interest rate risk management. The Executive Information
System will provide management with an up-to-the-minute comprehensive overview
of the Bank's condition, as well as detailed information, graphical
presentation, reports, and analysis.
In addition to the analytical benefits these applications will bring to the
management of the Bank, data generated from these modules will help direct
Second National's sales efforts toward more profitable relationships.
Increased Automated Transactions
During 1999, Second National will take steps to maximize the ratio of
automated transactions by encouraging greater use of the ATM, ACH, the IVR/Call
Center, and electronic transfer options. Redirecting manual or repetitive
transactions to automated environments will offer a two-fold benefit to Second
National. A higher ratio of automated transactions will provide branch staff
with more time for sales and service. At a lower per-transaction cost to the
Bank, increased automated transactions will reduce overall costs and ultimately
improve the Bank's efficiency ratio.
Corporate Services
Second National's Corporate Services Division will expand its current menu
of products and services to better suit the needs of small-to-medium size
businesses -- which are expected to increase usage of cash management services
by 38 percent over the next five years. This initiative is designed to make this
important service more competitive in the marketplace and to increase sales to
small businesses.
Growth
During 1999, Second National Bank will establish two de novo offices in
addition to opening a newly constructed and expanded Poland office. This
activity will bring Second National into its ninth Ohio county while further
strengthening the Bank's market position in Summit and Mahoning counties.
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Lake Cable
In the Lake Cable area of Jackson Township in Stark County, Second National
is renovating 1,200 square feet of space in an existing strip shopping center
for a new mini-branch. Lake Cable, a dynamic area with significant mortgage
activity and close proximity to North Canton and Canton, is a natural
progression for Second National that will build on the success of the Bank's
Akron and Green offices in nearby Summit County. In addition to high-level
banking professionals, including a branch manager and commercial lending
officer, the new office will offer a drive-up ATM and a night depository.
Twinsburg
Second National Bank will solidify its Summit County presence with the
opening of an office in Twinsburg, one of the county's fastest growing suburbs.
The new office, which will also have close proximity to our Solon office and
nearby branches in Portage County, is located in a newly constructed building in
front of a retail complex on Route 91. The 3,000 square-foot branch will feature
four teller stations, two personal banker service desks, and three offices for
financial professionals, including a branch manager and a commercial lender. The
full-service Twinsburg branch will also offer safe deposit boxes, a drive-up
ATM, three drive-thru lanes, and a night depository.
Poland Relocation
To accommodate its growing customer base and to take advantage of a prime
office location, Second National is constructing a new building to house the
Bank's Poland branch. The new building, being constructed on the well-traveled
Boardman-Poland Road (Rt. 224), just north of the branch's current location,
will afford the Poland office greater visibility and a broader range of
services.
With 3,000 square feet of office space -- nearly triple the size of the
current office -- the new Poland branch will offer more space for financial
professionals, safe deposit boxes, and four sit-down service desks. The office
will also feature two drive-thru lanes, a night depository, and a drive-up ATM.
Year 2000
The Year 2000 Compliance Plan, designed to provide for the continuance of
all banking and Trust operations through the century date change, encompasses
all current Second National branches and departments while anticipating
acquisitions. Second National has demonstrated its commitment to become fully
Year 2000 compliant by establishing a Y2K Department overseen by a Steering
Committee, allocating resources, and actively involving senior management. The
Bank's Y2K Plan was established using Office of the Comptroller of Currency
(OCC) guidelines that methodically address Year 2000 issues. The Y2K Steering
Committee Chairman provides monthly updates to executive management and reports
at least once each quarter to the Board of Directors.
Identifying critical issues began in the third quarter of 1997 and
established a level of understanding necessary for a project of this
significance. The Y2K Department was established and staffed at the beginning of
1998 to monitor and document progress toward full Year 2000 readiness.
Second National Bank followed OCC guidelines, enabling ease of benchmarking
with examining bodies, including five steps: Awareness, Assessment, Renovation,
Implementation, and Validation. Because of the complex and evolving nature of
Year 2000 information, the Awareness phase was viewed as an ongoing process with
a continuing dialogue to maintain confidence in the Bank by all stakeholders.
Customer awareness was raised through a statement stuffer, informational
brochure, and video. Employees are kept informed through internal memoranda,
articles in the Second Thoughts employee newsletter, reports to committees and
branch personnel, and the establishment of a "You're 2 Kind" award for
extraordinary contributions to the Year 2000 effort.
The Assessment phase included an extensive inventory of the Bank's
technology assets, including computer hardware, software, and peripherals.
Software licenses were collected for central storage in the Network Support
area, and all inventory information was entered into a centralized database for
monitoring and future upgrading.
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The Renovation phase incorporated testing of the ALLTEL Horizon system and
internal mission critical interfaces. The Implementation phase included
installation of the fully Y2K compliant ALLTEL Horizon core application
software, Southern Data Systems Teller Pro III operating system, and safe
deposit box system. Bank-wide Y2K compliance status will be reached by the end
of the second quarter of 1999.
The Validation phase commenced at the same time as Renovation with random
testing to document that all upgrades installed throughout the Bank were fully
functional and compliant.
Second National Bank recognizes the importance of coordination with outside
entities to ensure a continuous flow of information on Y2K issues. A formal
communication process with vendors, auditors, and regulatory agencies was
established in the third quarter of 1997 and is ongoing. Letters requesting
documentation of Y2K compliance or progress toward that goal were sent to third
party suppliers, including software companies, brokers, utilities, and
environmental services.
A Year 2000 Compliance Assessment worksheet and Year 2000 Customer Risk
Identification guideline were developed to evaluate commercial loan customers'
progress toward Y2K compliant status. The worksheet is a standard part of all
commercial loan packages and trust investor portfolios.
Y2K Contingency Planning
Responsible planning for the century date change must also include the
possibility of both individual sub-system and core processing computer
malfunctions. Hardware upgrades and replacement of non-compliant software,
coupled with testing, make system-wide failure unlikely.
Development of contingency plans and worst-case scenarios was deemed
prudent to enable Second National to minimize risk factors, ensure the safety
and soundness of the financial institution, and lessen or eliminate the
disruption of service to both the Bank and its customers. A Contingency Plan was
written in conjunction with a testing Plan in order to fulfill both OCC
requirements and to complete the Y2K Plan structure. A strategy is in place for
periodic review of the Y2K Contingency Plan.
We believe this approach to the planning and execution of the Y2K Plan will
result in compliance with all Year 2000 standards and will enable Second
National Bank to maintain our industry leadership position into the future.
A Look Ahead
During 1998, Second National uncovered new opportunities to enhance its
value advantage in the Bank's people, technology, and delivery systems; through
leadership and growth; and within the Bank's community banking philosophy.
The sum total of those efforts afforded Second National customers more
convenient and comprehensive products and services. For shareholders, the Bank's
pursuit of value translated into greater efficiencies and increased
competitiveness. By leveraging an expert workforce and the synergies of its
growing branch network, Second National benefitted all of its stakeholders.
In 1999, Second National will aggressively pursue the opportunities created
during 1998 -- and continue to excel in its financial services niche.
The Company has no significant industry segments which require disclosure.
MARKET AREA
Second National's primary market area consists of Trumbull, Mahoning,
Portage, Jefferson, Summit, Medina, Ashtabula and the southeast portion of
Cuyahoga counties in the northeastern corner of Ohio, to the east and south of
the Cleveland metropolitan area. The market area's economy is heavily influenced
by the manufacturing sector with an emphasis on steel, auto manufacturing and a
variety of related and smaller industries. The area has benefited from an
extensive transportation system comprised mainly of railroad and trucking
systems.
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COMPETITION
There is significant competition in the financial services industry in
northeastern Ohio among commercial banks. As a result of deregulation of the
financial services industry, Second Bancorp also competes with other providers
of financial services such as savings and loan associations, credit unions,
commercial finance companies, brokerage and securities firms, insurance
companies, commercial finance and leasing companies and the mutual fund
industry. Some of Second Bancorp's competitors, including certain regional bank
holding companies which have operations in Second Bancorp's market area, have
substantially greater resources than Second Bancorp, and as such, may have
higher lending limits and may offer other services not available through Second
National. Second Bancorp also faces significant competition, particularly with
respect to interest rates paid on deposit accounts, from well-capitalized local
thrift institutions. Second National competes on the basis of rates of interest
charged on loans, the rates of interest paid on funds, the availability of
services and responsiveness to the needs of its customers.
REGULATION
Second Bancorp is a one bank holding company and is regulated by the
Federal Reserve Bank (the "FRB"). Second National is a national bank and is
regulated by the Office of the Comptroller of the Currency (the "OCC"), as well
as the Federal Deposit Insurance Corporation (the "FDIC"). Dramatic changes have
developed over the past several years regarding minimum capital requirements for
financial institutions. A listing of the minimum requirements for capital and
Second Bancorp's capital position as of December 31, 1998 and 1997 are presented
in footnote 12 of Item 8; Financial Statements and Supplementary Data and is
hereby incorporated by reference.
Second Bancorp is subject to regulation under the Bank Holding Company Act
of 1956, as amended (the "Act"). The Act restricts the geographic and product
range of bank holding companies by circumscribing the types and locations of
institutions the holding companies own or acquire. Among the states where Second
Bancorp may acquire banks are Ohio and Pennsylvania. The Act also regulates
transactions between Second Bancorp and Second National and generally prohibits
tie-ins between credit and other products and services.
Second National is subject to regulation under the National Banking Act and
is periodically examined by OCC and is subject, as a member bank, to the rules
and regulations of the FRB. Second National is an insured institution and member
of the Bank Insurance Fund ("BIF") and also has approximately $435 million in
deposits acquired through acquisitions of savings and loan institutions that are
insured through the Savings Association Insurance Fund ("SAIF"). As such, Second
National is also subject to regulation by the FDIC. Establishment of branches is
subject to approval of the OCC and geographic limits established by state law.
FIRREA
FIRREA restructures the regulation, supervision and deposit insurance of
savings and loan associations and federal savings banks whose deposits were
formerly insured by the Federal Savings and Loans Insurance Corporation
("FSLIC"). FSLIC was replaced by the Savings Association Insurance Fund ("SAIF")
administered by the FDIC. A separate fund, the Bank Insurance Fund ("BIF"),
which was essentially a continuation of the FDIC's then existing fund, was
established for banks and state savings banks. An acquired thrift generally
would be required to continue its deposit insurance with the SAIF unless
significant exit and entrance fees were paid in connection with a conversion to
BIF insurance.
FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") substantially revised the bank regulatory and funding provisions of
the Federal Deposit Insurance Act and several other federal banking statutes.
Among other things, FDICIA requires federal banking agencies to broaden the
scope of regulatory corrective action taken with respect to banks that do not
meet minimum capital requirements and to take such actions promptly in order to
minimize losses to the FDIC. FDICIA established five capital tiers: "well
capitalized"; "adequately capitalized"; "undercapitalized"; "significantly
capitalized"; and "critically undercapitalized" and imposes significant
restrictions on the operations of a depository institution that is not in either
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of the first two of such categories. A depository institution's capital tier
will depend upon the relationship of its capital to various capital measures. A
depository institution will be deemed to be "well capitalized" if it
significantly exceeds the minimum level required by regulation for each relevant
capital measure, "adequately capitalized" if it meets each such measure,
"undercapitalized" if it is significantly below any such measure and "critically
undercapitalized" if it fails to meet any critical capital level set forth in
regulations. An institution may be deemed to be in a capitalization category
that is lower than is indicated by its actual capital position if it receives an
unsatisfactory examination rating or is deemed to be in an unsafe or unsound
condition or to be engaging in unsafe or unsound practices.
Under regulations adopted under these provisions, for an institution to be
well capitalized it must have a total risk-based capital ratio of at least 10%,
a Tier I risk-based capital ratio of at least 6% and a Tier I leverage ratio of
at least 5% and not be subject to any specific capital order or directive. For
an institution to be adequately capitalized, it must have a total risk-based
capital ratio of at least 8%, a Tier I risk-based capital ratio of at least 4%
and a Tier I leverage ratio of at least 4% (or in some cases 3%). Under the
regulations, an institution will be deemed to be undercapitalized if the bank
has a total risk-based capital ratio that is less than 8%, a Tier I risk-based
capital that is less than 4% or a Tier I leverage ratio of less than 4% (or in
some cases 3%). An institution will be deemed to be significantly
undercapitalized if the bank has a total risk-based capital ratio that is less
than 6%, a Tier I risk-based capital ratio that is less than 3%, or a leverage
ratio that is less than 3% and will be deemed to be critically undercapitalized
if it has a ratio of tangible equity to total assets that is equal to or less
than 2%.
FDICIA generally prohibits a depository institution from making a capital
distribution (including payment of dividends) or paying management fees to any
entity that controls the institution if it thereafter would be undercapitalized.
If an institution becomes undercapitalized, it will be generally restricted from
borrowing from the Federal Reserve, increasing its average total assets, making
any acquisitions, establishing any branches or engaging in any new line of
business. An undercapitalized institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency, which plan must, in
the opinion of such agency, be based on realistic assumptions and be "likely to
succeed" in restoring the institution's capital. In connection with the approval
of such a plan, the holding company of the institution must guarantee that the
institution will comply with the plan, subject to a limitation of liability
equal to a portion of the institution's assets. If an undercapitalized
institution fails to submit an acceptable plan or fails to implement such a
plan, it will be treated as if it is significantly undercapitalized.
Under FDICIA, bank regulators are directed to require "significantly
undercapitalized" institutions, among other things, to restrict business
activities, raise capital through a sale of stock, merge with another
institution and/or take any other action which the agency determines would
better carry out the purposes of FDICIA.
Within 90 days after an institution is determined to be "critically
undercapitalized", the appropriate federal banking agency must, in most cases,
appoint a receiver or conservator for the institution or take such other action
as the agency determines would better achieve the purposes of FDICIA. In
general, "critically undercapitalized" institutions will be prohibited from
paying principal or interest on their subordinated debt and will be subject to
other substantial restrictions.
FDICIA also contains a variety of other provisions that could affect the
operations of Second Bancorp, including new reporting requirements, regulatory
standards for real estate lending, "truth in savings" provisions, the
requirement that a depository institution give 90 days' prior notice to
customers and regulatory authorities before closing any branch, limitations on
credit exposure between banks, restrictions on loans to a bank's insiders and
guidelines governing regulatory examinations.
DEPOSIT INSURANCE ASSESSMENTS AND RECENT LEGISLATION
The FDIC is authorized to establish separate annual assessment rates for
deposit insurance for members of the BIF and the SAIF. The FDIC may increase
assessment rates for either fund if necessary to restore the fund's ratio of
reserves to insured deposits to its target level within a reasonable time and
may decrease such rates if such target level has been met. The FDIC has
established a risk-based assessment system for both BIF and SAIF members. Under
this system, assessments vary based on the risk the institution poses to its
deposit insurance
9
<PAGE> 11
fund. The risk level is determined based on the institution's capital level and
the FDIC's level of supervisory concern about the institution.
Based upon its respective level of deposits at December 31, 1998, the
projected BIF and SAIF assessments for Second National for 1999 will be
approximately $330,000.
INTERSTATE BANKING AND BRANCHING LEGISLATION
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "IBBEA") authorized interstate acquisitions of banks and bank holding
companies without geographic constraint beginning September 29, 1995. Beginning
June 1, 1997, the IBBEA also authorizes banks to merge with banks located in
another state provided that neither state has "opted out" of interstate
branching between September 29, 1994 and May 31, 1997. States could also enact
legislation permitting interstate merger transactions prior to June 1, 1997.
After acquiring interstate branches through a merger, a bank may establish
additional branches in that state at the same locations as any bank involved in
the merger could have established branches under state and federal law. In
addition, a bank may establish a de novo branch in another state that expressly
permits the establishment of such branches. A bank that establishes a de novo
interstate branch may thereafter establish additional branches on the same basis
as a bank that has established interstate branches through a merger transaction.
If a state "opts out" of interstate branching, no bank from another state
may establish a branch in that state, whether through a merger of de novo
establishment. Pennsylvania, the state in closest proximity to Second National,
has opted to permit interstate branching, creating the possibility of branching
into that state. To date, Second National has taken no action to branch into
Pennsylvania or any other state, however Second National may do so in the
future.
EMPLOYEES
The number of full time equivalent employees of Second Bancorp as of
December 31, 1998 was approximately 544. Second Bancorp considers its employee
relations to be good. None of the employees are covered by a collective
bargaining agreement.
ITEM 2. PROPERTIES
Second Bancorp's executive offices are located at Second National's main
office building in Warren, Ohio, which is leased by Second National under a
long-term triple net lease agreement with a term, including optional renewals,
expiring on October 31, 2029. Second National has the option to purchase the
main office facility before two optional renewal periods at the fair market
value in existence at that time. Second National owns six of its branch
locations, while Second National's 28 other branch and loan production office
locations are leased under lease and sublease agreements with remaining terms of
1 to 15 years. Second National also has leases for record retention and office
space with remaining lease terms of two and eight years, respectively.
ITEM 3. LEGAL PROCEEDINGS
Second Bancorp is subject to various pending and threatened lawsuits in
which claims for monetary damages are asserted in the ordinary course of
business. While any litigation involves an element of uncertainty, in the
opinion of management, liabilities, if any, arising from such litigation or
threat thereof will not have a material effect on the financial position or
results of operations of Second Bancorp.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Second Bancorp, Incorporated's Special Shareholders Meeting was held on
November 10, 1998. The results of the votes on the matters presented to
shareholders are as follows: Of the 7,063,144 issued and outstanding shares
eligible to vote, 6,047,310 were represented at the meeting. The shareholders
approved Proposal 1 regarding the merger of Trumbull Financial Corporation with
and into Second Bancorp with votes "for" of 5,667,547, votes "against" of
157,438 and votes "abstained" of 100,422. The shareholders approved Proposal 2
to increase the number of directors of Second Bancorp from seven (7) to eight
(8) with votes "for" of 5,631,828,
10
<PAGE> 12
votes "against" of 319,438 and votes "abstained" of 96,032. The shareholders
approved Proposal 3 to elect Dr. David A. Allen to Second Bancorp's Board of
Directors for a term ending on the date of Second Bancorp's 1999 annual meeting
of shareholders with votes "for" of 5,861,906 and votes "withheld" of 185,397.
The shareholders also approved Proposal 4 to amend Second Bancorp's articles for
the purpose of eliminating Second Bancorp's two classes of preferred shares with
votes "for" of 5,696,182, votes "against" of 98,962 and votes "abstained" of
130,661.
ITEM 4a. IDENTIFICATION OF EXECUTIVE OFFICERS
The following table sets forth the names and ages and business experience
for the last five years of each of the executive officers of the Corporation.
Each executive officer of the Corporation is appointed by the Board of Directors
on an annual basis, and serves at the pleasure of the Board.
<TABLE>
<CAPTION>
YEAR
NAME AGE POSITION AND EXPERIENCE APPOINTED
---- --- ----------------------- ---------
<S> <C> <C> <C>
Alan G. Brant....... 66 Chairman and President of Second Bancorp, Inc. and 1987
Chief Executive Officer of The Second National Bank of
Warren.
David H. Dye........ 54 Senior Vice President of Second Bancorp, Inc. and 1997
Executive Vice President and Chief Lending Officer of
The Second National Bank of Warren. Prior to 1997,
Regional President of Star Bank, N.A.
David L.
Kellerman......... 41 Treasurer of Second Bancorp, Inc. and Executive Vice 1987
President and Chief Financial Officer of The Second
National Bank of Warren.
Christopher
Stanitz........... 50 Senior Vice President of Second Bancorp, Inc. and Vice 1992
President of The Second National Bank of Warren.
Diane C. Bastic..... 55 Executive Officer of Second Bancorp, Inc. and Senior 1985
Vice President of The Second National Bank of Warren.
William Hanshaw..... 46 Executive Officer of Second Bancorp, Inc. and Senior 1989
Vice President of The Second National Bank of Warren.
Darryl E. Mast...... 48 Executive Officer of Second Bancorp, Inc. and Senior 1986
Vice President of The Second National Bank of Warren.
Terry L. Myers...... 49 Executive Officer of Second Bancorp, Inc. and Senior 1986
Vice President of The Second National Bank of Warren.
</TABLE>
11
<PAGE> 13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq National Market tier of The
Nasdaq Stock Market under the trading symbol SECD. As of March 15, 1999, the
number of shareholders of record of the Common Stock totaled 2,483. The detail
of stock prices and dividend payments are incorporated herein by reference from
Item 7; Management's Discussion and Analysis of Financial Condition and Results
of Operations. Dividend restrictions are detailed in footnote 12 of Item 8;
Second Bancorp's Financial Statements and Supplementary Data is incorporated
herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the consolidated
financial statements and accompanying footnotes beginning on page 26.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL DATA
Results of Operations:
Interest income............. $ 106,997 $ 104,990 $ 101,158 $ 97,110 $ 82,997
Interest expense............ 55,888 55,707 54,153 53,180 39,899
----------- ----------- ----------- ----------- -----------
Net interest income......... 51,109 49,283 47,005 43,929 43,098
Provision for loan losses... 10,579 4,205 5,072 3,176 2,463
Other income................ 12,754 11,101 10,008 9,431 6,742
Other expense............... 46,248 39,198 39,279 36,736 33,726
----------- ----------- ----------- ----------- -----------
Income before Federal income
taxes.................... 7,036 16,981 12,662 13,449 13,651
Federal income taxes........ 1,403 3,745 2,993 3,818 4,164
----------- ----------- ----------- ----------- -----------
Net income.................. $ 5,633 $ 13,236 $ 9,669 $ 9,631 $ 9,487
=========== =========== =========== =========== ===========
Per Common Share Data:(1)
Basic earnings.............. $ .53 $ 1.25 $ .93 $ .97 $ .96
Diluted earnings............ .52 1.25 .92 .92 .92
Cash dividends.............. .48 .40 .34 .29 .25
Book value, December 31..... 11.53 11.34 10.40 10.03 8.89
Market value, December 31... 22.25 25.38 15.69 14.38 10.75
Weighted-average shares
outstanding(1)
Basic.................... 10,665,597 10,555,921 9,876,174 8,852,511 8,733,242
Diluted.................. 10,742,622 10,616,752 10,555,060 10,481,653 10,359,486
Shares outstanding at
year-end(1).............. 10,688,450 10,606,749 10,503,660 8,927,490 8,753,466
Per Preferred Share Data:
Cash dividends.............. n/a n/a $ .75 $ 1.50 $ 1.50
Market value, December 31... n/a n/a n/a 31.50 23.75
</TABLE>
12
<PAGE> 14
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
As of December 31:
Total assets............. $ 1,430,233 $ 1,438,193 $ 1,397,194 $ 1,359,828 $ 1,308,065
Loans, net............... 960,114 858,321 808,396 753,095 677,563
Deposits................. 1,102,590 1,115,044 1,076,947 1,066,319 1,013,462
Shareholders' equity..... 123,273 120,318 106,415 102,818 90,509
Averages:
Total assets............. 1,464,803 1,424,211 1,384,343 1,342,786 1,221,181
Earning assets........... 1,386,894 1,351,117 1,301,032 1,263,023 1,158,557
Loans.................... 938,408 869,333 797,174 730,622 659,845
Deposits................. 1,086,074 1,079,809 1,072,303 1,036,869 987,390
Shareholders' equity..... 126,748 112,127 103,725 95,610 89,141
Ratios:
Return on average assets.... .38% .93% .70% .72% .79%
Return on average total
shareholders' equity..... 4.44 11.80 9.32 10.07 10.78
Return on average common
shareholders' equity..... 4.44 11.80 9.32 10.38 11.08
Net interest margin......... 3.84 3.78 3.73 3.58 3.82
Net overhead ratio.......... n/a n/a n/a n/a n/a
Efficiency ratio............ 70.11 63.04 67.11 67.26 66.67
Dividend pay-out............ 91.53 32.29 35.77 31.09 26.24
Average loans to average
deposits................. 86.40 80.51 74.34 70.46 66.83
Allowance for loan losses as
a percent of loans....... 1.11 1.02 1.13 1.14 1.16
Net charge-offs as a percent
of average loans......... .76 .79 .45 .34 .34
Non-performing loans to
total loans.............. .71 .80 1.17 .74 .92
Allowance for loans losses
to non-performing
loans.................... 155 128 96 155 132
Average equity to average
assets................... 8.65 7.87 7.49 7.12 7.30
</TABLE>
- ---------------
(1) Amounts have been retroactively restated for the two-for-one stock split,
effective May 1, 1997, and the three-for-two stock split, effective May 1,
1995.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
RESULTS OF OPERATIONS
Net income for 1998 was $5,633 and was affected by the merger activity
completed in 1998. The acquisition of Trumbull Financial Corporation,
headquartered in Warren, Ohio, and Enfin Corporation, headquartered in Solon,
Ohio, greatly increased the Corporation's asset size and earnings capacity for
the future. During 1998, however, merger related costs of $6,657 were taken to
accomplish the strategic growth. The acquisition of Enfin gives the Corporation
access to the commercial lending market in and around Solon, a suburb of
Cleveland, while the acquisition of Trumbull strengthens the Corporation's
dominance of the Trumbull County market. Also impacting earnings during 1998 was
the need to provide additional provision for loan losses. Net losses incurred
13
<PAGE> 15
during 1998, primarily commercial loan losses, exceeded $8.6 million for the
year, necessitating the increase in provision. Absent the merger costs and
related tax impact, net income for 1998 would have been $10,630. Net income for
1997 was $13,236 and was 37% greater than net income reported in 1996 of $9,669.
The net income for 1996 was impacted by the special one-time SAIF assessment
totaling $2,471. The Corporation's return on average assets ("ROA") was .38%,
.93%, and .70% for 1998, 1997, and 1996, respectively. Excluding merger costs,
ROA would have been .73% in 1998. The total shareholders' return on average
equity ("ROE") was 4.44% in 1998 compared to 11.80% in 1997 and 9.32% in 1996.
An increase in common stock of nearly $1.2 million was generated through the
dividend reinvestment program in both 1998 and 1997, thereby increasing the
shareholders' equity balances.
Basic earnings per common share were $.53 per share in 1998, down from
$1.25 in 1997. Basic earnings per share were $.93 in 1996. Diluted earnings per
share, which takes into effect the dilutive impact of the preferred stock which
was present through mid-1996 and other dilutive securities, were $.52 per share
in 1998, $1.25 in 1997, and $.92 in 1996. The Corporation declared a two-for-one
stock split for the common stock effective May 1, 1997. The Corporation's common
stock, trading under the NASDAQ symbol of SECD, has generally followed the path
of most bank stocks during 1998, peaking at $37.25 per share in the second
quarter and finishing the year at $22.25 per share. The stock price at year-end
1998 represents a price of 193% of book value. Dividends declared in 1998
totaled $.48 per share. This represents an increase of 20% over 1997, when
dividends declared were $.40 per share.
Revenue continues to be provided primarily from interest and fees on loans,
which totaled $79,963, $74,145, and $70,611 in 1998, 1997, and 1996,
respectively. This represents 67%, 64%, and 64% of total revenues for those
years. Interest income on securities is also a major source of revenue,
contributing 22%, 26%, and 27% of revenues in 1998, 1997, and 1996,
respectively. The shift to a greater concentration in earnings from loans
reflects the Corporation's efforts to more profitably employ the funds available
to it.
NET INTEREST INCOME
The Corporation was able to increase the net interest income in 1998
through an improvement in the net interest margin and an increase in average
earning assets. The net interest margin improved from 3.78% in 1997 to 3.84% in
1998. Net interest income increased by 3.7% from $49,283 in 1997 to $51,109 in
1998. Average earning assets increased by 2.6% to $1,386,894 in 1998. Similarly,
net interest income increased by 4.8% from 1996 to 1997 while average earning
assets increased by 3.8% and the net interest margin increased from 3.73% in
1996 to 3.78% in 1997. The Corporation continues to face tightening pressures on
the net interest margin; however, the Corporation has reacted proactively to
achieve a higher net interest margin, primarily through loan growth. Average
loans, primarily real estate mortgage loans, have increased consistently over
the past four years, growing at an average annual rate of 9%. Deposits averaged
$1,086,074 in 1998, representing a 1% increase over 1997.
The relationship between net interest income, FTE net interest income,
earning assets, and net interest margin for the past three years follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net interest income -- per financial statements...... $ 51,109 $ 49,283 $ 47,005
Tax equivalent adjustment............................ 2,102 1,798 1,517
---------- ---------- ----------
Net interest income -- FTE........................... $ 53,211 $ 51,081 $ 48,522
========== ========== ==========
Average earning assets............................... $1,386,894 $1,351,117 $1,301,032
Net interest margin.................................. 3.84% 3.78% 3.73%
</TABLE>
Net interest income can be analyzed through the use of the Yields Analysis
table. The table shows a three-year comparison of the average balance of
interest earning assets and interest bearing liabilities along with interest and
yields associated with them.
14
<PAGE> 16
SECOND BANCORP, INC. AND SUBSIDIARY
YIELDS ANALYSIS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ ------------------------------ ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
Taxable loans(1)(3).... $ 924,823 $79,229 8.57% $ 856,186 $73,509 8.59% $ 783,598 $ 69,871 8.92%
Tax-exempt loans(2).... 13,585 1,112 8.19 13,147 964 7.33 13,576 1,121 8.26
Taxable securities..... 368,421 22,945 6.23 411,075 27,142 6.60 451,575 27,833 6.16
Tax-exempt
securities........... 68,994 5,071 7.35 56,926 4,324 7.60 44,000 3,341 7.59
Federal funds sold..... 11,071 742 6.70 13,783 849 6.16 8,283 509 6.15
---------- ------- ---- ---------- ------- ---- ---------- -------- ----
Total interest
earning assets..... 1,386,894 109,099 7.87 1,351,117 106,788 7.90 1,301,032 102,675 7.89
Non-interest earning
assets................. 77,909 73,094 83,311
---------- ---------- ----------
TOTAL.................... $1,464,803 $1,424,211 $1,384,343
========== ========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest bearing
liabilities:
Demand deposits --
interest bearing..... $ 91,310 1,488 1.63 $ 88,324 1,533 1.74 $ 91,584 2,155 2.35
Savings deposits......... 263,855 7,494 2.84 266,500 7,563 2.84 281,984 7,709 2.73
Time deposits............ 626,440 34,589 5.52 621,847 34,552 5.56 609,615 34,224 5.61
Federal funds purchased
and securities sold
under agreements to
repurchase............. 138,652 6,525 4.71 130,298 6,172 4.74 97,987 4,366 4.46
Note payable............. 3,647 276 7.57 5,000 371 7.42
Other borrowed funds..... 3,008 170 5.65 2,851 163 5.72 2,874 150 5.22
Federal Home Loan Bank
advances............... 99,462 5,622 5.65 85,664 5,448 6.36 89,451 5,178 5.79
---------- ------- ---- ---------- ------- ---- ---------- -------- ----
Total interest bearing
liabilities............ 1,222,727 55,888 4.57 1,199,131 55,707 4.65 1,178,495 54,153 4.60
Non-interest bearing
liabilities:
Demand deposits........ 104,469 103,138 89,120
Accrued expenses and
other liabilities...... 10,859 9,815 13,003
---------- ---------- ----------
Other liabilities...... 115,328 112,953 102,123
Shareholders' equity..... 126,748 112,127 103,725
---------- ---------- ----------
TOTAL.................... $1,464,803 $1,424,211 $1,384,343
========== ========== ==========
Net interest earnings
(FTE).................. 53,211 51,081 48,522
Taxable equivalent
adjustment............. 2,102 1,798 1,517
------- ------- --------
Net interest income (per
financial
statements)............ $51,109 $49,283 $ 47,005
------- ------- --------
Net yield on interest
earning assets......... 3.84% 3.78% 3.73%
==== ==== ====
</TABLE>
- ---------------
(1) For purposes of these computations, non-accruing loans are included in the
daily average loan amounts outstanding.
(2) The tax-exempt income and yields are shown on a tax equivalent basis using
the 34% marginal Federal tax rates in effect during the three years.
(3) Loan fees are included in the interest reported for loans. Those fees
amounted to $2,636 in 1998, $2,906 in 1997, and $3,255 in 1996.
15
<PAGE> 17
You can further analyze the change in net interest income by separating the
volume and rate impact of the change. The following table details the breakdown
of the major categories affecting the change:
<TABLE>
<CAPTION>
1998 COMPARED TO 1997 1997 COMPARED TO 1996
DUE TO CHANGE IN DUE TO CHANGE IN
--------------------------- ---------------------------
RATE/VOLUME ANALYSIS(1) VOLUME RATE NET VOLUME RATE NET
----------------------- ------ ------- ------ ------ ------- ------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in FTE interest
income:
Taxable loans...................... $5,893 $ (173) $5,720 $6,472 $(2,834) $3,638
Tax-exempt loans................... 31 117 148 (35) (122) (157)
Taxable securities................. (2,816) (1,381) (4,197) (2,496) 1,805 (691)
Tax-exempt securities.............. 917 (170) 747 981 2 983
Federal funds sold................. (167) 60 (107) 338 2 340
------ ------- ------ ------ ------- ------
Total interest bearing assets........ $3,858 $(1,547) $2,311 $5,260 $(1,147) $4,113
====== ======= ====== ====== ======= ======
Interest bearing liabilities:
Demand deposits -- Interest
bearing......................... $ 52 $ (97) $ (45) $ (77) $ (545) $ (622)
Savings deposits................... (75) 6 (69) (423) 277 (146)
Time deposits...................... 255 (218) 37 686 (358) 328
Federal funds purchased and
securities sold under agreements
to repurchase................... 396 (43) 353 1,440 366 1,806
Note payable....................... (276) 0 (276) (100) 5 (95)
Other borrowed funds............... 9 (2) 7 (1) 14 13
Federal Home Loan Bank advances.... 878 (704) 174 (219) 489 270
------ ------- ------ ------ ------- ------
Total interest bearing liabilities... $1,239 $(1,058) $ 181 $1,306 $ 248 $1,554
====== ======= ====== ====== ======= ======
Total effect on net interest
income............................. $2,619 $ (489) $2,130 $3,954 $(1,395) $2,559
====== ======= ====== ====== ======= ======
</TABLE>
- ---------------
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of the change in each.
PROVISION FOR LOAN LOSSES
The provision for loan losses totaled $10,579 in 1998, or .92% of average
loans, significantly higher than the average level of .52% over the past five
years. The provision for loan losses was $4,205 in 1997, $5,072 in 1996, $3,176
in 1995, and $2,463 in 1994. The increase in 1998 can be attributed to higher
than historically normal levels of net charge-offs for the commercial loan
portfolio. Net charge-offs as a percent of average commercial loans were 1.55%
in 1998 and .68% in 1997.
NON-INTEREST INCOME
Non-interest income totaled $12,754 in 1998, which represented a 15%
increase over 1997. Service charges on deposit accounts improved by 5% to $4,145
in 1998. The increase is attributable to the increase in revenue from ATM
services provided and improvements in the collection of return check and
overdraft fees. Service charges on deposits had increased 17% from 1996 to 1997.
Trust fee income totaled $2,820 in 1998, a 10% improvement over the prior year.
The revenue increase was partly attributable to new trust relationships as well
as increases in the market value of assets under management. Trust fee income
was $2,562 in 1997 and $2,335 in 1996. Other fee income increased by 18% during
1998 and included gains from the sale of mortgages and Small Business
Administration ("SBA") loans. Other income had increased by 6% the prior year
through the combination of earnings from secondary mortgage and SBA sale
activities.
16
<PAGE> 18
Included in non-interest income over the past three years were pre-tax
gains on the sale of securities. During 1998, the security portfolio realized
gains in the amount of $1,007. During 1997, the Corporation established a
charitable foundation to carry on the Corporation's many charitable and civic
activities. The gain realized on the appreciated stock donated to the foundation
was $352, which represented a significant portion of the total gains realized in
1997 of $515.
NON-INTEREST EXPENSE
The Corporation continues to emphasize expense control and to be efficient
in its utilization of resources to manage assets. Excluding merger costs,
non-interest expenses as a percentage of average assets were 2.70% in 1998
compared to 2.75% in 1997. The table below details the percentage change in each
non-interest expense category over the past three years:
<TABLE>
<CAPTION>
PERCENTAGE CHANGE
--------------------------------
1998 OVER 1997 1997 OVER 1996
-------------- --------------
<S> <C> <C>
Salaries and benefits.................................. 4% 7%
Net occupancy.......................................... 2 5
Equipment.............................................. 13 26
Professional services.................................. 3 8
Assessment on deposits and other taxes................. (8) (20)
Amortization of goodwill and other intangibles......... (15) (14)
Other expenses......................................... 5 10
</TABLE>
Equipment expense increased by 13% in 1998, due primarily to the costs
associated with automation efforts during the past two years. During 1997, the
Corporation migrated to an in-house data processing environment, while in 1998,
the Corporation continued implementing new technologies and upgraded the
acquired companies' equipment to newer technologies. In 1997, excluding the
one-time charge for donating $824 of stock to the charitable foundation, other
expenses would have actually decreased by 1%.
INCOME TAXES
The provision for income taxes was $1,403, $3,745, and $2,993 in 1998,
1997, and 1996, respectively. The effective tax rate for the Corporation was
19.9%, 22.1%, and 23.6% during the same periods. The reduction in the effective
tax rate in 1997 and 1998 was due to the continuation of the accumulation of
tax-exempt securities and the realization of investment tax credits through the
Bank's participation in low-income housing projects as well as reduced net
income for 1998.
BALANCE SHEET
The average asset growth rate has averaged 5% over the past four years. The
1998 growth rate in average assets was 2.9%. The slower growth rate is
attributable to the planned de-emphasis of the indirect automobile lending
program. Also as an industry, banks are experiencing slower deposit growth rates
due to increased competition from non-traditional alternatives, especially
mutual funds. Deposit balances finished the year totaling in excess of $1.1
billion, representing a decrease of 1% from the previous year-end. Deposits grew
3.5% from December 31, 1996 to December 31, 1997.
EARNING ASSETS
Securities:
The securities portfolio of the Corporation is used to provide an adequate
rate of return to the Corporation along with appropriate levels of liquidity and
as a tool for efficient tax management and interest rate risk management. The
accounting treatment for the securities portfolio is determined by the
Corporation's intent regarding particular security holdings. Securities
held-to-maturity are purchased with the intent and ability to
17
<PAGE> 19
hold them to maturity and are, therefore, carried at amortized cost. Securities
previously classified as held-to-maturity by Trumbull were reclassified to
available-for-sale at the consummation of the transaction. Securities are
purchased to satisfy yield enhancement, liquidity, interest rate risk
management, and pledging needs. Purchases in longer maturities that provided
yield enhancement included purchases of tax-exempt securities which provide the
additional benefit of tax reduction.
The securities portfolio totaled $354,415 as of December 31, 1998. That
balance represents a 26% decrease over the prior year-end. The December 31, 1997
balance of $483,095 included $312,328 classified as available-for-sale and was
2% less than the prior year-end. Security balances have been declining as the
Corporation increases its loan balances. Growth in securities has been
concentrated in tax-exempt issues. Mortgage-backed securities have declined
significantly over the past year as market rates are lower and mortgage
refinancings have risen.
The average yield on the portfolio is 6.5% as of December 31, 1998. During
the past year, the Corporation realized $1,007 in net gains on the sale of
securities. In 1997 and 1996, net security gains totaled $515 and $462,
respectively. As interest rates have declined over the past year, the
Corporation's net unrealized gain or loss position for the portfolio has
increased from $3,387 to $4,695.
Summary yield and maturity information regarding the securities portfolios
on December 31 follows. Yields are calculated on a fully taxable equivalent
basis using the marginal Federal income tax rate of 34% for 1998.
<TABLE>
<CAPTION>
BOOK VALUE
-----------------------------------------------------------------------
1998 1997 1997 1996 1996
AVAILABLE- 1998 AVAILABLE- HELD-TO- AVAILABLE- HELD-TO-
FOR-SALE YIELD FOR-SALE MATURITY FOR-SALE MATURITY
---------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other U.S.
Government agencies and
corporations:
Under 1 year............... $ 24,364 5.2% $ 40,270 $ 250 $ 23,912 $ 751
1 to 5 years............... 56,520 5.7 37,479 0 37,188 2,000
5 to 10 years.............. 8,769 6.2 17,500 7,959 16,926 7,987
Over 10 years.............. 0 0.0 0 0 0 0
-------- --- -------- -------- -------- --------
Total................... 89,653 5.6 95,249 8,209 78,026 10,738
Obligations of states and
political subdivisions:
Under 1 year............... 2,758 7.8 2,686 0 3,126 0
1 to 5 years............... 18,154 8.0 20,905 0 13,348 0
5 to 10 years.............. 34,359... 7.6 32,631 0 28,881 0
Over 10 years.............. 21,705... 7.1 6,809 0 6,395 0
-------- --- -------- -------- -------- --------
Total................... 76,976 7.6 63,031 0 51,750 0
Corporate:
Under 1 year............... 0 0.0 0 0 1,002 0
1 to 5 years............... 10,446 6.4 10,288 0 0 0
5 to 10 years.............. 0 0.0 0 0 0 0
Over 10 years.............. 0 0.0 0 0 0 0
-------- --- -------- -------- -------- --------
Total................... 10,446 6.4 10,288 0 1,002 0
Mortgage-backed securities... 164,262 6.5 131,529 161,249 149,118 187,755
Equity securities............ 13,078 7.2 12,231 0 10,989 0
-------- --- -------- -------- -------- --------
$354,415 6.5% $312,328 $169,458 $290,885 $198,493
======== === ======== ======== ======== ========
</TABLE>
18
<PAGE> 20
Mortgage-backed securities have various stated maturities through September
2027. The estimated weighted-average maturity of this segment of the portfolio
is 5.8 years.
Loans:
Listed below is the Corporation's loan distribution at the end of each of
the last 5 years:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Commercial.......................... $373,244 $347,173 $332,127 $301,870 $264,177
Consumer............................ 230,561 238,245 261,487 239,991 236,125
Real estate mortgage................ 367,048 281,729 224,017 219,949 185,224
-------- -------- -------- -------- --------
Balance December 31................. $970,853 $867,147 $817,631 $761,810 $685,526
======== ======== ======== ======== ========
</TABLE>
An analysis of maturity and interest rate sensitivity of commercial loans
as of December 31, 1998 follows:
<TABLE>
<CAPTION>
ONE YEAR ONE TO OVER
OR LESS FIVE YEARS FIVE YEARS TOTAL
-------- ---------- ---------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Fixed rate....................................... $24,456 $ 88,806 $ 88,376 $201,638
Variable rate.................................... 56,214 47,660 67,732 171,606
------- -------- -------- --------
Total commercial loans........................... $80,670 $136,466 $156,108 $373,244
======= ======== ======== ========
</TABLE>
The Corporation emphasizes growth in real estate loans and commercial
balances. The Corporation emphasizes real estate lending through its branch
network, reaching a broad range of customers. The Corporation has benefited from
this approach along with the use of mortgage loan originators and correspondent
lender relationships. Generally, the loans sold into the secondary mortgage
market make funds available for reuse in mortgage or other lending activities,
generate a net gain (including origination fee income) from the sale, limit the
interest rate risk caused by holding long-term, fixed-rate loans, and build a
portfolio of serviced loans which generate fee income for the Corporation. The
serviced portfolio of mortgages totaled $295 and $377 million as of December 31,
1998 and 1997, respectively.
Commercial loans are generated through a calling program targeting
medium-size companies. The Corporation is also generating an increasing volume
of Small Business Administration ("SBA") loans. The Corporation sells the
guaranteed portion of the SBA loans originated. The sales generated $658 and
$498 in net revenues, including $173 and $143 in revenues from the value of the
servicing retained in 1998 and 1997, respectively. The amount of SBA loans being
serviced by the Corporation totaled approximately $10.4 and $7.7 million at
December 31, 1998 and 1997, respectively.
The Bank de-emphasized its indirect lending program with automobile dealers
within the Bank's primary market areas in 1996, choosing to permit more funds to
be available to allow for commercial and real estate loan growth. In 1996, the
Bank shifted its focus on indirect lending, strictly limiting the acquisition of
lower-quality "C" and "D" type paper. Prior to that, the Bank accepted a higher
volume of lower-quality paper utilizing a tiered pricing system designed to
compensate the Bank for the higher risk associated with the loans. The Bank is
still active in generating loans from automobile dealers within the Bank's
market area; however, future growth is targeted in higher-quality loans.
The Corporation's loans are granted to customers within the immediate trade
area of the Corporation. The mix is diverse, covering a wide range of borrowers.
The Corporation monitors and controls concentrations within a particular
industry or segment. As of December 31, 1998, the Corporation had a
concentration in commercial real estate loans totaling approximately $258
million, approximately 68.5% of which were owner-occupied businesses, including
medical office buildings, retail, and fast-food restaurants within the
Corporation's market area.
19
<PAGE> 21
ASSET QUALITY
The reserve for loan losses is analyzed in the table below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------ ------ ------ ------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Balance at January 1........................ $ 8,837 $9,235 $8,715 $7,963 $7,124
Charge-offs:
Commercial................................ 6,734 2,435 2,051 775 535
Real estate............................... 820 12 56 26 74
Consumer.................................. 3,055 2,992 3,497 2,474 1,925
------- ------ ------ ------ ------
10,609 5,439 5,604 3,275 2,534
Recoveries:
Commercial................................ 1,213 108 155 312 310
Real estate............................... 50 0 46 18 58
Consumer.................................. 669 717 851 521 542
------- ------ ------ ------ ------
1,932 825 1,052 851 910
------- ------ ------ ------ ------
Net charge-offs............................. 8,677 4,614 4,552 2,424 1,624
Additions:
Charged to operations..................... 10,579 4,205 5,072 3,176 2,463
------- ------ ------ ------ ------
Balance at December 31...................... $10,739 $8,826 $9,235 $8,715 $7,963
======= ====== ====== ====== ======
Reserve for loan losses as a percentage of:
Year end loans............................ 1.11% 1.02% 1.13% 1.14% 1.16%
Non-performing loans...................... 155% 128% 96% 155% 127%
Net charge-offs........................... 124% 191% 203% 360% 490%
</TABLE>
Conforming adjustments for the pooled company for the fiscal quarter ending
December 31, 1997 included recoveries of $5, charge-offs of $54, and provision
for loan losses of $60.
Net charge-offs as a percent of average loans by major loan category are
shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial............................................. 1.55% 0.68% 0.61% 0.17% 0.09%
Real estate mortgage................................... 0.23% 0.00% 0.00% 0.00% 0.01%
Consumer............................................... 0.98% 0.85% 1.08% 0.82% 0.61%
Total net charge-offs to average loans................. 0.92% 0.53% 0.57% 0.33% 0.25%
</TABLE>
Significantly impacting the reserve for loan losses in 1998 was net
charge-off activity totaling $8.7 million, substantially from the commercial
lending portfolio. The losses and additional provision for loan losses were
associated with analysis of specific credits. Additionally, the majority of the
charge-offs occurred in the fourth quarter of 1998, following a detailed review
of all problem credits and additional adverse information regarding the
charged-off credits. Included in 1997's activity was the reclassification of
$2.4 million from loans to other assets. During 1997, one of the Bank's
borrowers, whose loan balance was included in non-performing loans as of
December 31, 1996, settled all their obligations with the Bank by placing
approximately $2.7 million in a third party trust. The balance was substantially
collected during 1998.
20
<PAGE> 22
The following presents a breakdown of the allocation of the loan loss
allowance by loan category for each of the last five years:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------------------------------------------------------
LOAN CATEGORY 1998 1997 1996 1995 1994
------------- -------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial..................... $ 6,351 59% $4,817 54% $5,296 57% $4,477 51% $4,092 52%
Consumer....................... 2,952 28 3,311 38 3,327 36 3,635 42 3,219 40
Real Estate.................... 1,436 13 698 8 612 7 603 7 652 8
------- --- ------ --- ------ --- ------ --- ------ ---
$10,739 100% $8,826 100% $9,235 100% $8,715 100% $7,963 100%
======= === ====== === ====== === ====== === ====== ===
</TABLE>
The increase in the loan loss reserve allocation to the commercial category
is the result of allocation to specific problem credits. The decrease in the
loan loss allowance allocated to consumer loans is the result of the run-off of
lower quality "C" and "D" type paper and the corresponding reduction in loss
experience. The increase in allocation of the loan loss allowance to real estate
loans reflects growth in loan balances from the Trumbull acquisition.
The determination of the reserve for loan losses is based on Management's
evaluation of the potential losses in the loan portfolio considering, among
other relevant factors, repayment status, borrowers' ability to repay,
collateral, and current and foreseeable economic conditions. The Bank utilizes
its internal loan gradings for commercial loans in conjunction with historical
loss experience for loans of each grade level and current economic trends as
parts of its analysis in determining the adequacy of its reserve for loan
losses. During the course of the year, the Corporation continued to update the
factors used in determining the appropriate level of loan losses for each major
category of loans based on loss experience within each category of loans.
Below is a table listing the non-accrual, past due, and restructured loans
at the end of the last five years:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Non-accrual loans............................ $4,130 $5,819 $7,271 $3,957 $4,153
Past due loans............................... 2,725 1,075 2,158 1,635 2,108
Restructured loans........................... 61 13 171 25 33
------ ------ ------ ------ ------
Total........................................ $6,916 $6,907 $9,600 $5,617 $6,294
====== ====== ====== ====== ======
Percent of loans at year end................. .71% .80% 1.17% .74% .87%
Other real estate owned.................... $ 79 $ 0 $ 0 $ 27 $ 165
</TABLE>
Loans 30 to 89 days past due, excluding non-accrual and restructured loans
included in the table above, amounted to $8,706, or .90% of outstanding loans,
as of December 31, 1998, as compared to $10,273, or 1.18% of loans on December
31, 1997. Loans then current where some concerns existed as to ability of the
borrower to comply with loan repayment terms approximated $28,352 on December
31, 1998 and $33,779 on December 31, 1997. Such loans have been and are being
closely monitored by Management.
Further discussion on loan quality and credit risk are presented in Note
1h, 7 and 20 of Item 8; Second Bancorp's Financial Statements and Supplementary
Data are incorporated herein by reference.
21
<PAGE> 23
FUNDING SOURCES
Deposits:
The average amounts of deposits are summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Demand deposits -- non-interest bearing................ $ 104,469 $ 103,138 $ 89,120
Demand deposits -- interest bearing.................... 91,310 88,324 91,584
Savings deposits....................................... 263,855 266,500 281,984
Time deposits.......................................... 626,440 621,847 609,615
---------- ---------- ----------
$1,086,074 $1,079,809 $1,072,303
========== ========== ==========
</TABLE>
Average deposits increased by 1% in 1998 with slight increases in average
time deposits and interest bearing demand deposits. During 1997, non-interest
bearing demand deposits increased through the introduction of a "totally free"
checking product along with increased balances from corporate customers. Savings
deposits declined in both 1998 and 1997 as customers chose to seek higher
yielding alternatives.
On December 31, 1998, time deposits over $100 totaled $79,434. The Bank
continues to maintain strong relationships with the various public entities
centered in the primary markets of the Bank which contribute to the balance of
time deposits over $100. The maturity schedule for time deposits over $100 as of
December 31 is given in the table below:
<TABLE>
<CAPTION>
1998 1997
-------- --------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
MATURING IN:
3 months or less...................................... $28,595 $32,136
3 to 6 months......................................... 15,621 27,447
6 to 12 months........................................ 19,525 20,811
Over 12 months........................................ 15,693 10,200
------- -------
$79,434 $90,594
======= =======
</TABLE>
Other Sources of Funds:
The repurchase agreement program provides a sweep feature on the customer's
primary business account, along with competitive market rates of interest, for
their excess funds. The success of this product reflects the strong emphasis the
Bank places on offering competitive products, coupled with personalized service
to the small- to mid-size businesses operating in the Bank's various markets.
Federal funds purchased and securities sold under agreements to repurchase
averaged $135 million in 1998 with the majority of the average balances
representing the retail sweep product.
The Corporation also has available to it unsecured lines of credit with
correspondent banks totaling $15 million. The lines of credit are renewable
annually and bear interest at a floating rate based on several indices. There
were no outstanding borrowings under these lines as of December 31, 1998 or
1997.
The Corporation also has access to federal tax deposits on a daily basis.
After being deposited by customers, the tax deposits are held at the Corporation
up to a self-imposed limit of $6 million until they are drawn upon by the
federal government. The balance of these funds was $861 and $3,492 as of
December 31, 1998 and 1997, respectively. The Corporation occasionally uses
federal funds purchased from other financial institutions as a source of
short-term funding. The Corporation had no federal funds purchased as of
December 31, 1998 or 1997.
The Bank also is a member of the Federal Home Loan Bank ("FHLB") system and
utilizes the various advance programs offered by the FHLB. The funds are drawn
from the FHLB for various terms through 2007 and
22
<PAGE> 24
are utilized to provide long-term funding to offset the interest rate risk
inherent with holding long-term, fixed-rate mortgages. The balances of these
advances were $72,782 and $58,403 as of December 31, 1998 and 1997,
respectively.
CAPITAL
The shareholders' equity increased to $123,273 at December 31, 1998 from
$120,318 a year earlier. The increase was primarily attributed to the earnings
retained this year after common stock dividend payments. In 1997, shareholders'
equity increased by $13,903 primarily through earnings retention and SFAS No.
115 adjustments. The impact of the change in unrealized market value adjustment
on securities available-for-sale, net of tax (SFAS No. 115 adjustment) resulted
in a net unrealized gain position of $3,097 at December 31, 1998 versus a net
unrealized gain position of $2,813 at December 31, 1997. The Corporation also
increased common stock by $1,170 through the dividend reinvestment program in
1998 and by $1,183 in 1997. Shareholders may invest cash dividends and voluntary
cash payments in additional shares at a 5% discount without payment of brokerage
commissions or service charges. Common stock was also increased by the exercise
of $377 of options. In 1997, common stock increased by $717 due to option
exercise activities. In 1997, $474 of treasury stock was repurchased, while in
1996 the repurchase totaled $319. On February 27, 1998, the Board of Directors
rescinded the authorization to repurchase shares of its common stock. As of
December 31, 1998, the Corporation had repurchased 50,400 shares. Effective June
25, 1996, the Corporation called for the redemption of all the outstanding
shares of the Series A $1.50 preferred stock. Virtually all preferred
stockholders exercised their conversion rights prior to the redemption date. The
net effect was a transfer of approximately $12.7 million in capital from
preferred stock to common stock.
The Corporation has consistently had qualifying capital under the
risk-based capital requirements in excess of those required to meet the
"well-capitalized" standards. For further details on capital ratios, see Note
12.
The Corporation trades under the symbol SECD on the NASDAQ National Market
System. The total market capitalization of the Corporation was approximately
$237.8 million at December 31, 1998. The table below lists the high and low
trading prices for the common stock by quarter for the last three years. The
price ranges and per share dividend figures set forth below have been adjusted
to reflect the two-for-one stock split effective May 1, 1997.
<TABLE>
<CAPTION>
QUARTER FIRST SECOND THIRD FOURTH YEAR
------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
1998
High........................................ $34.75 $37.25 $31.50 $26.00 $37.25
Low......................................... 24.88 27.00 25.75 19.75 19.75
Dividends Declared.......................... .11 .12 .12 .13 .48
1997
High........................................ $18.50 $22.25 $24.50 $28.00 $28.00
Low......................................... 15.06 17.75 20.75 21.88 15.06
Dividends Declared.......................... .10 .10 .10 .10 .40
1996
High........................................ $14.94 $14.13 $17.00 $16.50 $17.00
Low......................................... 13.75 12.50 13.63 14.88 12.50
Dividends Declared.......................... .10 .07 .10 .07 .34
</TABLE>
The Corporation's price for its common stock increased to a trading range
of $27.00 to $37.25 per share in the second quarter of 1998 and subsequently
closed the year at $22.25. The Corporation's stock has generally followed the
market trend for traded bank stocks. The common stock closed at $25.38 at
December 31, 1997, representing a 62% increase from the 1996 year-end close.
Book value per common share was $11.53 and $11.34 at December 31, 1998 and 1997,
respectively.
The Corporation has historically paid cash dividends on a quarterly basis
and has periodically paid stock dividends at the discretion of the Board of
Directors. The payment and amount of future dividends on the
23
<PAGE> 25
common stock will be determined by the Board of Directors. The payment will
depend on, among other things, earnings, financial condition, and cash
requirements of the Corporation at the time that such payment is considered, and
on the ability of the Corporation to receive dividends from the Bank, the amount
of which is subject to regulatory limitations. For 1998, 1997, and 1996, the
dividend-payout ratio for the Corporation was 91.53%, 32.29%, and 35.77%,
respectively.
LIQUIDITY
Management of the Corporation's liquidity position is necessary to ensure
that funds are available to meet the cash flow needs of depositors and borrowers
as well as the operating cash needs of the Corporation. Funds are available from
a number of sources including maturing securities, payments made on loans, the
acquisition of new deposits, the sale of packaged loans, borrowing from the
FHLB, and overnight lines of credit of over $37 million through correspondent
banks. The parent company has three major sources of funding, including
dividends from the Bank, $15 million in unsecured lines of credit with
correspondent banks which are renewable annually, and access to the capital
markets. The net cash provided by operating activities for 1998, 1997, and 1996
were approximately $4 million, $17 million, and $19 million, respectively. As
discussed in Note 12, the Bank is subject to regulation and may be limited in
its ability to pay dividends to the parent company. Accordingly, consolidated
cash flows may not represent cash available to common stockholders.
Additional discussion regarding the Company's liquidity and capital
resources is set forth in Notes 10, 11, and 12 of Item 8; Second Bancorp's
Financial Statements and Supplementary Data are incorporated herein by
reference.
FORWARD-LOOKING STATEMENTS
The sections that follow, Market Risk Management and Other, contain certain
forward-looking statements (as defined in the Private Securities Litigation
Reform Act of 1995). These forward-looking statements may involve significant
risks and uncertainties. Although the Corporation believes that the expectations
reflected in such forward-looking statements are reasonable, actual results may
differ materially from these results discussed in these forward-looking
statements.
MARKET RISK MANAGEMENT
Market risk is the risk of economic loss from adverse changes in the fair
value of financial instruments due to changes in (a) interest rates, (b) foreign
exchange rates, or (c) other factors that relate to market volatility of the
rate, index, or price underlying the financial instrument. The Corporation's
market risk is composed primarily of interest rate risk. The Corporation's
Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate
sensitivity position of the Corporation and establishing policies to monitor and
limit the exposure to interest rate risk. Since nearly the Corporation's entire
interest rate risk exposure relates to the financial instrument activity of the
Bank, the Bank's Board of Directors reviews the policies and guidelines
established by ALCO.
The primary objective of asset/liability management is to provide an
optimum and stable net interest margin, after-tax return on assets and return on
equity capital, as well as adequate liquidity and capital. Interest rate risk is
monitored through the use of two complementary measures: dynamic gap analysis
and earnings simulation models. While each of the measurement techniques has
limitations, taken together they represent a reasonably comprehensive tool for
measuring the magnitude of interest rate risk inherent in the Corporation.
The dynamic gap analysis measures the amount of repricing risk associated
with the balance sheet at a specific point in time. Expected cash flows from
fixed rate instruments are defined utilizing contractual maturities and
anticipated cash flows through early repayment of loans, early calls and
paydowns of securities, and early withdrawals of deposits. Variable rate
instrument's repricing frequencies are categorized according to their earliest
repricing opportunity. Core deposits with noncontractual maturities are included
in the gap repricing distributions based on historical patterns of pricing
behavior.
The earnings simulation model forecasts earnings for a one-year horizon
frame under a variety of interest rate scenarios. Management evaluates the
impact of the various rate simulations against earnings in a stable
24
<PAGE> 26
interest rate environment. The most recent model projects net income would
increase by 6.5% if interest rates would immediately rise by 200 basis points.
It projects a decrease in net income of 3.8% if interest rates would immediately
fall by 200 basis points. Management believes this reflects a slight asset
sensitive position for the one-year time horizon. The earnings simulation model
includes assumptions about how the various components of the balance sheet and
rate structure are likely to react through time in different interest rate
environments. These assumptions are derived from historical analysis and
Management's outlook.
Interest rate sensitivity is managed through the use of security portfolio
management techniques, the use of fixed rate long-term borrowings from the FHLB,
the establishment of rate and term structures for time deposits and loans, and
the sale of long-term fixed rate mortgages through the secondary mortgage
market. Although the Corporation has available to it the use of off-balance
sheet swap instruments to manage interest rate risk, these instruments are
historically rarely utilized. Management expects interest rates to be relatively
stable during 1999 and believes that the current modest level of asset
sensitivity is appropriate.
OTHER
Year 2000:
The Corporation has initiated the process of preparing its computer systems
and applications for the Year 2000. This process involves modifying or replacing
certain hardware and software used by the Corporation. The software utilized is
primarily originated and serviced by external providers. The Corporation is
communicating with those providers to ensure that appropriate steps are being
taken to remedy any Year 2000 issues. Management has completed the awareness and
inventory stages of the process and is substantially complete with the process
assessment, analysis, and conversion phases of the efforts. The process
assessment included a review of the information systems used in each process,
including related hardware and software, the involvement of third parties, and
any affected systems. Management expects to have all necessary system and
application changes implemented and tested in 1999. Management is also working
with significant customers, vendors, and business counterparties to monitor the
progress of their Year 2000 efforts. Management believes it has an effective
plan in place to resolve the Year 2000 issue in a timely manner and, thus far,
activities have tracked in accordance with original plans. Under the unlikely
scenario that the additional phases to the Year 2000 efforts are not completed,
the Corporation could be materially adversely affected as a result of not being
able to process transactions related to its business activities. In addition,
non-compliance by third parties (including loan customers) and disruptions to
the economy in general resulting from Year 2000 issues could also have a
negative impact of undeterminable magnitude on the Corporation. Total cost
associated with the process, including the cost of acquiring certain hardware
and software and the internal and external costs relating to modifying the
systems, will be approximately $880. In 1998, $370 of that total was expended,
with the balance to be spent in 1999. Additionally, the impact on operating
costs in 1998 was not material, and less than $100 is anticipated to be expended
in 1999. Purchased hardware and software will be capitalized in accordance with
normal policy. Personnel and all other costs related to the process are being
expensed as incurred. The costs of the process and the expected completion dates
are based on Management's best estimates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See information appearing under the caption "Market Risk Management"
appearing in Item 7. Management's Discussion and Analysis.
25
<PAGE> 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SECOND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash and demand balances due from banks..................... $ 45,478 $ 31,910
Federal funds sold.......................................... 4,000 11,444
Securities:
Available-for-sale (at market value)...................... 354,415 312,328
Held-to-maturity (market value of $169,458)............... 0 170,767
Loans....................................................... 970,853 867,147
Less reserve for loan losses................................ 10,739 8,826
---------- ----------
Net loans.............................................. 960,114 858,321
Premises and equipment...................................... 17,119 14,961
Accrued interest receivable................................. 8,709 9,019
Goodwill and intangible assets.............................. 5,749 6,548
Other assets................................................ 34,649 22,895
---------- ----------
Total assets........................................... $1,430,233 $1,438,193
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand -- non-interest bearing............................ $ 115,624 $ 113,175
Demand -- interest bearing................................ 101,080 90,340
Savings................................................... 274,728 268,033
Time deposits............................................. 611,158 643,496
---------- ----------
Total deposits......................................... 1,102,590 1,115,044
Federal funds purchased and securities sold under agreements
to repurchase............................................. 122,482 131,127
Other borrowed funds........................................ 861 3,492
Federal Home Loan Bank advances............................. 72,782 58,403
Accrued expenses and other liabilities...................... 8,245 9,809
---------- ----------
Total liabilities...................................... 1,306,960 1,317,875
Shareholders' equity:
Preferred stock, no par value;
Series A: 1,500,000 shares authorized in 1997; 718,750
issued and 0 shares outstanding in 1997............... 0
Series B: 1,500,000 shares authorized in 1997.......... 0
Common stock, no par value; 20,000,000 shares
authorized; 10,738,850 and 10,657,149 shares issued in
1998 and 1997, respectively........................... 36,901 35,354
Treasury stock, 50,400 shares.......................... (793) (793)
Net unrealized holding gains on available-for-sale
securities, net of tax.................................... 3,097 2,813
Retained earnings........................................... 84,068 82,944
---------- ----------
Total shareholders' equity............................. 123,273 120,318
---------- ----------
Total liabilities and shareholders' equity............. $1,430,233 $1,438,193
========== ==========
</TABLE>
See Notes To Consolidated Financial Statements.
26
<PAGE> 28
SECOND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
FOR THE CALENDAR YEAR
-----------------------------------------------
1998 1997 1996
------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
INTEREST INCOME
Loans (including fees):
Taxable.......................................... $ 79,229 $ 73,509 $ 69,871
Exempt from federal income taxes................. 734 636 740
Securities:
Taxable.......................................... 22,945 27,142 27,833
Exempt from federal income taxes................. 3,347 2,854 2,205
Federal funds sold................................. 742 849 509
----------- ----------- -----------
Total interest income......................... 106,997 104,990 101,158
INTEREST EXPENSE
Deposits........................................... 43,571 43,648 44,088
Federal funds purchased and securities sold under
agreements to repurchase......................... 6,525 6,172 4,366
Note payable....................................... 0 276 371
Other borrowed funds............................... 170 163 150
Federal Home Loan Bank advances.................... 5,622 5,448 5,178
----------- ----------- -----------
Total interest expense........................ 55,888 55,707 54,153
----------- ----------- -----------
Net interest income................................ 51,109 49,283 47,005
Provision for loan losses.......................... 10,579 4,205 5,072
----------- ----------- -----------
Net interest income after provision for loan
losses........................................... 40,530 45,078 41,933
NON-INTEREST INCOME
Service charges on deposit accounts................ 4,145 3,963 3,384
Trust fees......................................... 2,820 2,562 2,335
Security gains..................................... 1,007 515 462
Other.............................................. 4,782 4,061 3,827
----------- ----------- -----------
Total non-interest income..................... 12,754 11,101 10,008
----------- ----------- -----------
NON-INTEREST EXPENSE
Salaries and employee benefits..................... 19,080 18,422 17,206
Merger costs....................................... 6,657 0 0
Net occupancy...................................... 3,966 3,888 3,716
Equipment.......................................... 3,073 2,731 2,170
Professional services.............................. 2,137 2,070 1,918
Assessment on deposits and other taxes............. 1,660 1,811 2,251
SAIF special assessment............................ 0 0 2,471
Amortization of goodwill and other intangibles..... 799 937 1,090
Other.............................................. 8,876 9,339 8,457
----------- ----------- -----------
Total non-interest expense.................... 46,248 39,198 39,279
----------- ----------- -----------
Income before federal income taxes................. 7,036 16,981 12,662
Income tax expense (benefit):
Current.......................................... 1,864 3,356 3,979
Deferred......................................... (461) 389 (986)
----------- ----------- -----------
Total federal income tax expense.............. 1,403 3,745 2,993
----------- ----------- -----------
NET INCOME......................................... $ 5,633 $ 13,236 $ 9,669
=========== =========== ===========
Preferred stock dividends........................ 0 0 (456)
----------- ----------- -----------
Net income applicable to common stock............ $ 5,633 $ 13,236 $ 9,213
=========== =========== ===========
NET INCOME PER COMMON SHARE
Basic............................................ $ .53 $ 1.25 $ .93
Diluted.......................................... $ .52 $ 1.25 $ .92
Weighted-average common shares outstanding:
Basic............................................ 10,665,597 10,555,921 9,876,174
Diluted.......................................... 10,742,622 10,616,752 10,555,060
</TABLE>
See Notes To Consolidated Financial Statements.
27
<PAGE> 29
SECOND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
HOLDING
PREFERRED COMMON TREASURY (LOSS) RETAINED COMPREHENSIVE
STOCK STOCK STOCK GAIN EARNINGS TOTAL INCOME
--------- ------- -------- ---------- -------- -------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996........ $12,731 $20,183 $ 0 $1,673 $68,231 $102,818
Net income...................... 9,669 9,669 $ 9,669
Unrealized loss on securities of
$2,072, net of
reclassification adjustment
for gains included in net
income of $305................ (2,377) (2,377) (2,377)
-------
Comprehensive income............ $ 7,292
=======
Cash dividends declared:
Common stock ($.34 per
share)...................... (3,459) (3,459)
Preferred stock ($1.50 per
share)...................... (456) (456)
Exercise of stock options....... 276 276
Common stock issued............. 24 24
Common stock issued -- dividend
reinvestment plan............. 271 271
Conversion of preferred stock to
common stock.................. (12,700) 12,696 (4)
Redemption of preferred stock... (25) (3) (28)
Purchase of treasury stock...... (319) (319)
------- ------- ----- ------ ------- --------
BALANCE, DECEMBER 31, 1996...... 6 33,450 (319) (704) 73,982 106,415
Net income...................... 13,236 13,236 $13,236
Unrealized gain on securities of
$3,857, net of
reclassification adjustment
for gains included in net
income of $340................ 3,517 3,517 3,517
-------
Comprehensive income............ $16,753
=======
Cash dividends declared:
Common stock ($.40 per
share)...................... (4,274) (4,274)
Exercise of stock options....... 717 717
Common stock issued -- dividend
reinvestment plan............. 1,183 1,183
Conversion of preferred stock to
common stock.................. (6) 4 (2)
Purchase of treasury stock...... (474) (474)
------- ------- ----- ------ ------- --------
BALANCE, DECEMBER 31, 1997...... $ 0 35,354 (793) 2,813 82,944 120,318
Adjustment to conform pooled
company's fiscal year-end..... 19 646 665 $ 934
=======
Net income...................... 5,633 5,633 $ 5,633
Unrealized gain on securities of
$930, net of reclassification
adjustment for gains included
in net income of $665......... 265 265 265
-------
Comprehensive income............ $ 5,898
=======
Cash dividends declared:
Common stock ($.48 per
share)...................... (5,155) (5,155)
Exercise of stock options....... 377 377
Common stock issued............. 1,170 1,170
------- ----- ------ ------- --------
BALANCE, DECEMBER 31, 1998...... $36,901 $(793) $3,097 $84,068 $123,273
======= ===== ====== ======= ========
</TABLE>
See Notes To Consolidated Financial Statements.
28
<PAGE> 30
SECOND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE CALENDAR YEAR
-----------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income............................................... $ 5,633 $ 13,236 $ 9,669
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses................................ 10,579 4,205 5,072
Provision for depreciation............................... 2,614 2,317 1,846
Provision for amortization of intangibles................ 799 937 1,090
(Accretion) amortization of investment discount and
premium................................................ (1,811) 657 1,218
Provision for loss on servicing rights................... 380 18 0
Deferred income taxes.................................... (461) 389 (986)
Securities gains......................................... (1,007) (515) (462)
Other gains, net......................................... (2,104) (1,272) (751)
Decrease (increase) in interest receivable............... 73 (1,118) (87)
Decrease in interest payable............................. (220) (170) (273)
Originations of loans held-for-sale...................... (118,838) (49,770) (50,650)
Proceeds from sales of loans held-for-sale............... 120,948 50,341 51,728
Net change in other assets and other liabilities......... (12,653) (2,588) 1,139
--------- --------- ---------
Net cash provided by operating activities................ 3,932 16,667 18,553
INVESTING ACTIVITIES
Proceeds from maturities of
securities -- held-to-maturity......................... 87,945 31,315 26,405
Proceeds from maturities of
securities -- available-for-sale....................... 166,019 61,794 85,520
Proceeds from sales of
securities -- available-for-sale....................... 86,245 62,794 60,299
Donation of securities to establish charitable
foundation............................................. 202 824 0
Purchases of securities -- held-to-maturity.............. (12,384) (3,249) (11,234)
Purchases of securities -- available-for-sale............ (201,734) (142,017) (138,456)
Net increase in loans.................................... (94,526) (52,957) (60,590)
Net increase in premises and equipment................... (4,817) (3,039) (2,918)
--------- --------- ---------
Net cash provided by (used for) investing activities..... 26,950 (44,535) (40,974)
FINANCING ACTIVITIES
Net increase (decrease) in demand, interest bearing
demand and savings deposits............................ 21,745 8,225 (17,139)
Net (decrease) increase in time deposits................. (36,850) 29,972 27,893
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase......... 405 44,405 (14,342)
Decrease in note payable................................. 0 (5,000) 0
Net (decrease) increase in borrowings.................... (2,696) (497) 825
Net (repayments) advances from Federal Home Loan Bank.... (3,324) (48,586) 35,030
Cash dividends........................................... (5,155) (4,274) (3,915)
Redemption/conversion of preferred stock................. 0 (2) (32)
Purchase of treasury stock............................... 0 (474) (319)
Issuance of common stock................................. 1,547 1,900 571
--------- --------- ---------
Net cash (used by) provided by financing activities...... (24,328) 25,669 28,572
--------- --------- ---------
Increase (decrease) in cash and cash equivalents......... 6,554 (2,199) 6,151
Cash and cash equivalents at beginning of year........... 42,924 45,553 39,402
--------- --------- ---------
Cash and cash equivalents at end of year................. $ 49,478 $ 43,354 $ 45,553
========= ========= =========
</TABLE>
SUPPLEMENTARY CASH FLOW INFORMATION:
Cash paid for 1) Federal income taxes -- $2,885, $3,745, and $2,993 for the
12 months ended December 31, 1998, 1997, and 1996, respectively; and 2)
Interest -- $56,108, $55,533, and $54,527 for the 12 months ended December 31,
1998, 1997, and 1996, respectively. Conforming adjustments for the pooled
company for the fiscal quarter ending December 31, 1997 included $746,
$(12,276), and $11,100 for operating, investing, and financing activities,
respectively.
See Notes To Consolidated Financial Statements.
29
<PAGE> 31
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, 1998
1. STATEMENT OF ACCOUNTING POLICIES
Nature of Operations: Second Bancorp, Inc. (the Corporation) is a one bank
holding company with its sole subsidiary being The Second National Bank of
Warren (the Bank), headquartered in Warren, Ohio, with 33 branches and one loan
production office operating in Northeast Ohio. In addition to general commercial
banking, the Bank engages in trust and mortgage banking activities and other
financially related businesses.
The accounting policies followed by Second Bancorp, Inc. conform to
generally accepted accounting principles and to general practices within the
banking industry. The following is a description of the more significant
accounting policies:
a. Principles of Consolidation: Significant intercompany balances and
transactions between the Corporation and the Bank have been eliminated.
The consolidated financial statements have been prepared to give
retroactive effect to the August 20, 1998 acquisition of Enfin, Inc.
(Enfin) and to the November 19, 1998 acquisition of Trumbull Financial
Corporation (Trumbull). In accordance with the rules of the Securities
and Exchange Commission, Trumbull's financial statements and selected
financial data for the years ended September 30, 1994 through 1997 have
been combined with the Corporation's financial statements and selected
financial data for the years ended December 31, 1994 through 1997,
respectively. Certain prior year amounts have been reclassified to
conform with the current year presentation.
b. Use of Estimates: The preparation of the financial statements in
conformity with generally accepted accounting principles requires
Management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual
results could differ from these estimates.
c. Business Combinations: Business combinations which have been accounted
for under the pooling of interests method of accounting requires the
assets, liabilities, and shareholders' equity of the merged entity to
be retroactively combined with the Corporation's respective accounts at
recorded value. Prior period financial statements have been restated to
give effect to business combinations accounted for under this method.
d. Cash Equivalents: Cash equivalents include amounts due from banks and
federal funds sold. Generally, federal funds are purchased and sold for
periods of less than 30 days.
e. Securities: Debt and equity securities are classified as
held-to-maturity, available-for-sale, or trading. Securities classified
as held-to-maturity are measured at amortized or historical cost,
securities available-for-sale and trading at fair value. Adjustments to
fair value of the securities available-for-sale, in the form of
unrealized holding gains and losses, are excluded from earnings and
reported net of tax as a separate component of shareholders' equity.
Adjustments to fair value of securities classified as trading are
included in earnings. Management determines the appropriate
classification of debt securities at the time of purchase and
re-evaluates such designation as of each balance sheet date. Debt
securities are classified as held-to-maturity when the Corporation has
the positive intent and ability to hold the securities to maturity.
Classifying securities as available-for-sale allows the Corporation to
sell securities to fund liquidity and manage the Corporation's interest
rate risk. The Corporation does not maintain a trading account.
Securities previously classified as held-to-maturity by Trumbull were
reclassified to available-for-sale at the consummation of the
transaction.
The amortized cost of the debt securities classified as
held-to-maturity or available-for-sale is adjusted for amortization of
premiums and accretion of discounts to maturity or, in the case of
mortgage-backed securities, over the estimated life of the security.
Such amortization is included in interest income from
30
<PAGE> 32
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
investments. Interest and dividends are included in interest income
from investments. Realized gains and losses, and declines in value
judged to be other than temporary, are included in net securities gains
(losses). The cost of securities sold is based on the specific
identification method.
f. Revenue Recognition: Interest on loans is accrued and credited to
operations based upon the principal amount outstanding. Premiums on
acquired loans have been deducted from the related interest income and
are amortized over the remaining useful life of the loans acquired.
Discounts and premiums on acquired deposits have been deducted or added
respectively from the related interest expense and are being accreted
or amortized over the remaining useful life of the deposits. The
accrual of interest income generally is discontinued when a loan
becomes, in Management's opinion, doubtful of being collectible. When
interest accruals are discontinued, interest credited to income for the
current year is reversed, and interest accrued in prior years is
charged to the reserve for loan losses.
The Corporation accounts for loan origination and commitment fees and
certain direct loan origination costs by deferring the net fees, or net
costs, and amortizing them as an adjustment of the related loan's
yield. The Corporation is amortizing these amounts over the contractual
life of the related loans. Net unamortized deferred costs, primarily
representing costs of acquiring indirect automobile loans, were $2,055
and $2,231 at December 31, 1998 and 1997, respectively.
g. Loans Available-for-Sale: From time to time, the Corporation will sell
loans it originated, mostly mortgages. The loans are reclassified as
available-for-sale and are recorded at the aggregate cost or market
value by loan.
h. Reserve for Loan Losses: The reserve for loan losses is maintained at a
level believed adequate by Management to absorb potential losses in the
loan portfolio. Management's determination of the adequacy of the
reserve is based upon an evaluation of the collectibility of the loans.
These evaluations take into consideration such factors as changes in
the nature and volume of the loan portfolio, current economic
conditions that may affect the borrower's ability to pay, overall
quality, and a review of specific problem loans. Certain loans are
accounted for under SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan -Income Recognition and
Disclosures." These standards address the accounting for certain loans
when it is probable that amounts due pursuant to the contractual terms
of the loan will not be collected. This evaluation is inherently
subjective and requires Management to make estimates regarding the
amounts and timing of future cash flows expected to be received on
impaired loans that could be susceptible to change. To determine the
amount of impaired loans, the Corporation analyzes the expected cash
flows of non-accrual loans. To the extent that the net present value of
expected cash flows is less than the carrying amount of an individual
loan, the loan balance is included as impaired loans.
i. Premises and Equipment: Premises and equipment are stated at cost, less
accumulated depreciation and amortization. The provision for
depreciation and amortization is computed generally by the
straight-line method. Leasehold improvements are amortized over the
shorter of the terms of the respective leases or the estimated useful
lives.
j. Intangible Assets: Intangible assets resulting from the excess of the
purchase price over net identifiable tangible assets acquired through
acquisitions are specifically identified when determinable. The excess
goodwill is amortized based on the estimated useful life of the
long-term assets acquired and on an accelerated basis. The core deposit
intangible is amortized both on an accelerated basis and on a straight-
line basis over the estimated useful life. Original estimated useful
lives for the core deposit intangible and goodwill range from 10 to 14
years and 8 to 22 years, respectively. Accumulated amortization as of
December 31, 1998 and 1997 were $8,716 and $7,878, respectively.
k. Mortgage Servicing Rights: The Corporation recognizes as separate
assets the value of mortgage servicing rights, whether those rights are
acquired through loan origination activities or through purchase
31
<PAGE> 33
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
activities. Management stratifies servicing rights based on term or
method of acquisition. Capitalized mortgage servicing rights are
amortized on an accelerated basis over the estimated life of the loans
sold. Management evaluates the recoverability of the mortgage servicing
rights in relation to the impact of actual and anticipated loan
portfolio prepayments, foreclosures, and delinquency experience.
l. Interest Rate Risk Management: As part of managing the Corporation's
interest rate risk, a variety of financial instruments may from time to
time be used to hedge market values and to alter the cash flow
characteristics of certain on-balance sheet instruments. The derivative
financial instruments used primarily consist of interest rate caps and
swaps. The derivative instruments used to manage interest rate risk are
linked with a specific asset or liability or a group of related assets
or liabilities at the inception of the derivative contract and have a
high degree of correlation with the associated balance sheet item
during the hedge period. Net interest income or expense on derivative
contracts used for interest rate risk management is accrued. Deferred
amounts are amortized into interest income or expense over either the
remaining original life of the derivative instrument or the expected
life of the associated asset or liability. Unrealized gains or losses
are not recognized on the balance sheet.
m. Federal Income Taxes: Deferred federal income taxes are provided for
differences between tax and financial statement bases of assets and
liabilities at year-end. Deferred taxes are recognized using the
liability method, whereby tax rates are applied to cumulative temporary
differences based on when and how they are expected to affect the tax
return. Deferred tax assets and liabilities are adjusted for tax rate
changes.
n. Per Share Data: In 1997, the FASB issued SFAS No. 128, "Earnings per
Share." Statement 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants, and convertible securities.
Diluted earnings per share is very similar to the previously reported
fully diluted earnings per share. All earnings per share amounts for
all periods have been presented, and where appropriate, restated to
conform to the Statement 128 requirements. The Corporation had a
two-for-one stock split on May 1, 1997 and a three-for-two stock split
on May 1, 1995. All of the share and per share data have been restated
to reflect these stock splits.
2. RECENT ACCOUNTING PRONOUNCEMENTS
a. Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities: Certain provisions of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," relating to repurchase agreements,
securities lending and other similar transactions, and pledged
collateral were deferred a year by SFAS No. 127, and were adopted
prospectively as of January 1, 1998. The Statement provides consistent
standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings based on a control-
oriented "financing-components" approach. Under this approach, after a
transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. The adoption of these
provisions did not have a material impact on financial position or
results of operations.
b. Reporting Comprehensive Income: In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income." This statement establishes
standards for reporting the components of comprehensive income and
requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be included
in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income includes net income as
well as certain items that are reported directly within a separate
component of stockholders' equity and bypass net income. The Corporation
adopted the provisions of this statement in 1998. These disclosure
requirements had no impact on financial position or results of
operations.
32
<PAGE> 34
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
c. Disclosures about Segments of an Enterprise and Related Information: In
June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." The provisions of the statement
require disclosure of financial and descriptive information about an
enterprise's operating segments in annual and interim financial reports
issued to shareholders. The statement defines an operating segment as a
component of an enterprise that engages in business activities that
generate revenue and incur expense, whose operating results are reviewed
by the chief operating decision maker in the determination of resource
allocation and performance, and for which discrete financial information
is available. The Corporation is deemed to have only one segment and,
therefore, adoption of this statement had no impact on financial
position or results of operation.
d. Accounting for Derivative Instruments and Hedging Activities: In June
1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The provisions of this statement
require that derivative instruments be carried at fair value on the
balance sheet. The statement continues to allow derivative instruments
to be used to hedge various risks and sets forth specific criteria to be
used to determine when hedge accounting can be used. The statement also
provides for offsetting changes in fair value or cash flows of both the
derivative and the hedged asset or liability to be recognized in
earnings in the same period; however, any changes in fair value or cash
flows that represent the ineffective portion of a hedge are required to
be recognized in earnings and cannot be deferred. For derivative
instruments not accounted for as hedges, changes in fair value are
required to be recognized in earnings.
The provisions of this statement become effective for quarterly and
annual reporting beginning January 1, 2000. Although the statement
allows for early adoption in any quarterly period after June 30, 1998,
the Corporation has no plans to adopt the provisions of SFAS No. 133
prior to the effective date. The impact of adopting the provisions of
this statement on the Corporation's financial position, results of
operations and cash flow subsequent to the effective date is not
currently estimable and will depend on the financial position of the
Corporation and the nature and purpose of the derivative instruments in
use by Management at that time.
3. MERGERS AND ACQUISITIONS
On August 20, 1998, Second Bancorp acquired Enfin, Inc. (Enfin), a $44
million asset bank holding company headquartered in Solon, Ohio, in a
transaction accounted for as a pooling of interests. Second Bancorp issued .5
million shares of common stock to the shareholders of Enfin, based upon an
exchange ratio of .95 shares of Second Bancorp common stock for each outstanding
share of Enfin common stock. The historical consolidated financial statements
have been restated to reflect this transaction.
On November 19, 1998, Second Bancorp acquired Trumbull Financial
Corporation (Trumbull), a $462 million asset unitary thrift holding company
headquartered in Warren, Ohio, in a transaction accounted for as a pooling of
interests. Second Bancorp issued 3.3 million shares of common stock to the
shareholders of Trumbull based upon an exchange ratio of 3.78 shares of Second
Bancorp common stock for each outstanding share of Trumbull common stock. The
historical consolidated financial statements have been restated to reflect this
transaction.
Prior to the merger, Trumbull used a fiscal year end of September 30. The
1998 financial statements combine each company's year ended December 31. The
restated financial statements for the years ended December 31, 1997 and 1996
combine Second Bancorp's and Enfin's financial statements for the years ended
December 31, 1997 and 1996 with Trumbull's financial statements for the years
ended September 30, 1997 and 1996, respectively. Due to the different fiscal
year ends, Trumbull's results for the three months ended December 31, 1997 are
reflected as an adjustment in the accompanying statement of shareholders'
equity. Net income for Trumbull for the period totaled $915, with dividends
declared of $269 and a net change in unrealized gains on securities
available-for-sale of $19.
33
<PAGE> 35
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net interest income, net income, and diluted income per common share for
Second Bancorp, Trumbull, and Enfin, as originally reported for the two years
ended December 31, 1997 prior to restatement, are as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Net interest income:
Second Bancorp......................................... $34,751 $33,861
Trumbull............................................... 12,576 11,575
Enfin.................................................. 1,956 1,569
------- -------
Combined................................................. $49,283 $47,005
======= =======
Net income:
Second Bancorp......................................... $ 8,975 $ 8,096
Trumbull............................................... 3,344 834
Enfin.................................................. 917 283
------- -------
Combined................................................. $13,236 $ 9,213
======= =======
Diluted net income per common share:
Second Bancorp......................................... $ 1.32 $ 1.27
Trumbull............................................... 3.85 .96
Enfin.................................................. 1.67 .52
------- -------
Combined................................................. $ 1.25 $ .92
======= =======
</TABLE>
The net interest income, net income, and diluted net income per common
share for the period October 1, 1997 through December 31, 1997 that were
excluded from the results of operations were $3,177, $915, and $.09,
respectively. Dividends declared during the period October 1 to December 31,
1997 by Trumbull were $269. Trumbull's net interest income, net income, and
diluted income per share for the period January 1, 1998 through September 30,
1998 were $10,204, $2,861, and $.27, respectively.
Merger expenses incurred in 1998 as a result of the Enfin and Trumbull
acquisitions totaled $6,657 and consisted of: personnel-related costs of $2,931;
professional fees of $1,917; system conversion expenses of $810; and
miscellaneous expenses of $999.
4. RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The Bank is required to maintain average reserve balances with the Federal
Reserve Bank. The average amount of those reserve balances for the year ended
December 31, 1998 was approximately $2,255, which includes a $1,750 compensating
balance for services provided by the Federal Reserve Bank during 1998.
34
<PAGE> 36
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. SECURITIES
The following is a summary of securities:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ----------------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available-for-Sale:
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $ 88,739 $ 984 $ (70) $ 89,653
Obligations of states and political
subdivisions.................................. 74,218 2,855 (97) 76,976
Corporate securities............................ 10,247 199 0 10,446
Mortgage-backed securities...................... 163,787 818 (343) 164,262
-------- ------ ------- --------
Total debt securities......................... 336,991 4,856 (510) 341,337
Equity securities............................... 12,729 406 (57) 13,078
-------- ------ ------- --------
Total securities.............................. $349,720 $5,262 $ (567) $354,415
======== ====== ======= ========
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1997 COST GAINS LOSSES VALUE
- ----------------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available-for-Sale:
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $ 94,530 $ 768 $ (49) $ 95,249
Obligations of states and political
subdivisions.................................. 60,933 2,114 (16) 63,031
Corporate securities............................ 10,263 30 (5) 10,288
Mortgage-backed securities...................... 129,981 1,834 (286) 131,529
-------- ------ ------- --------
Total debt securities......................... 295,707 4,746 (356) 300,097
Equity securities............................... 11,925 306 0 12,231
-------- ------ ------- --------
Total securities.............................. $307,632 $5,052 $ (356) $312,328
======== ====== ======= ========
Held-to-Maturity:
U.S. Treasury securities and obligations of
other U.S. Government agencies and
corporations.................................. $ 8,237 $ 8 $ (36) $ 8,209
Mortgage-backed securities...................... 162,530 395 (1,676) 161,249
-------- ------ ------- --------
Total securities.............................. $170,767 $ 403 $(1,712) $169,458
======== ====== ======= ========
</TABLE>
35
<PAGE> 37
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated market value of securities on December 31,
1998 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED MARKET
COST VALUE
--------- ---------
<S> <C> <C>
Under 1 year........................................... $ 27,069 $ 27,121
1 to 5 years........................................... 83,396 85,120
5 to 10 years.......................................... 41,331 43,129
Over 10 years.......................................... 21,408 21,705
-------- --------
173,204 177,075
Mortgage-backed securities............................. 163,787 164,262
Equity securities...................................... 12,729 13,078
-------- --------
$349,720 $354,415
======== ========
</TABLE>
Information relating to sales of available-for-sale securities for the
three years ended December 31, 1998 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Proceeds from sales of securities............. $96,971 $62,794 $60,299
Gross realized gains.......................... $ 1,024 $ 708 $ 590
Gross realized losses......................... (17) (193) (128)
Income tax associated with net gains.......... 342 175 157
------- ------- -------
After tax gain................................ $ 665 $ 340 $ 305
------- ------- -------
Impact on dilutive earnings per share......... $ 0.06 $ 0.03 $ 0.03
======= ======= =======
</TABLE>
On December 31, 1998 and 1997, securities with a carrying value of $156,078
and $211,635, respectively, were pledged to secure repurchase agreements,
deposits of public funds, and for other purposes.
6. LOANS
Loans consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Commercial............................................. $373,244 $347,173
Consumer............................................... 230,561 238,245
Real estate............................................ 346,081 278,809
Real estate -- construction............................ 20,967 2,920
-------- --------
$970,853 $867,147
======== ========
</TABLE>
36
<PAGE> 38
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998 and 1997, the Corporation serviced mortgage loans for
others totaling $295,423 and $377,480, respectively. Following is an analysis of
the activity for capitalized mortgage loan servicing rights acquired during the
years ending December 31:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Balance at January 1...................................... $3,544 $4,029
Additions................................................. 1,019 649
Sales..................................................... (925) (219)
Amortization.............................................. (575) (689)
Change in valuation allowance............................. (380) (18)
------ ------
Balance at December 31.................................... $2,683 $3,752
====== ======
</TABLE>
Conforming adjustments for the pooled company for the fiscal quarter ending
December 31, 1997 included additions of $9, amortization of $164, and additions
to the valuation allowance of $53.
Following is an analysis of the aggregate changes in the valuation
allowances for mortgage servicing rights for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Balance at January 1........................................ $ 71 $ 0
Additions................................................... 380 18
---- ---
Balance at December 31...................................... $451 $18
==== ===
</TABLE>
The Corporation also services Small Business Administration (SBA) loans for
others totaling $10,394 and $7,705 as of December 31, 1998 and 1997,
respectively. Amounts capitalized as originated servicing rights were $225 and
$118 in 1998 and 1997, respectively. Capitalized servicing rights amortized were
$66 and $25 in 1998 and 1997, respectively.
The Bank has granted loans to the officers and directors of both the
Corporation and the Bank and their associates. Related-party loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons. The
aggregate dollar amounts of these loans were $10,904 and $9,344 at December 31,
1998 and 1997, respectively. New loans and advances totaled $11,081 and payments
were $9,521 in 1998.
7. ASSET QUALITY
Reserve for loan losses:
Changes in the reserve for loan losses for each of the last three years
ended December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
<S> <C> <C> <C>
Balance at beginning of year.................... $ 8,837 $9,235 $8,715
Charge-offs..................................... (10,609) (5,368) (5,328)
Recoveries...................................... 1,932 754 776
------- ------ ------
Net charge-offs............................... (8,677) (4,614) (4,552)
Provision for loan losses....................... 10,579 4,205 5,072
------- ------ ------
Balance at end of year.......................... $10,739 $8,826 $9,235
======= ====== ======
Reserve for loan losses as a percent of total
loans......................................... 1.11% 1.02% 1.13%
</TABLE>
37
<PAGE> 39
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Conforming adjustments for the pooled company for the fiscal quarter ending
December 31, 1997 included recoveries of $5, charge-offs of $54, and provision
for loan losses of $60.
Non-accrual, past-due and restructured loans (non-performing loans):
Non-accrual loans are loans that are no longer accruing interest at the
discretion of Management. This occurs when Management determines that the
borrower can no longer service the debt, but the loan is adequately secured with
collateral or the borrower is able to repay the principal portion of the loan in
the future. Past-due loans are loans with principal payments more than 90 days
past due. Both interest and principal are expected to be repaid. Restructured
loans include loans whose original terms were redesigned to allow the customer
to remain current and repay the loan. Also listed is other real estate owned
which represents real estate acquired through the default of loans. The Bank's
practice is to carry other real estate owned at the lower of cost or fair market
value, less estimated costs to sell.
<TABLE>
<CAPTION>
DECEMBER 31
----------------
1998 1997
------ ------
<S> <C> <C>
Non-accrual loans.......................................... $4,130 $5,819
Past-due loans............................................. 2,725 1,075
Restructured loans......................................... 61 13
------ ------
Total...................................................... $6,916 $6,907
====== ======
Percent of total loans at year end....................... .71% .80%
Other real estate owned (net of reserve)................... $ 79 $ 0
</TABLE>
During 1997, the obligations of one of the Bank's borrowers were included
in non-performing loans as of December 31, 1996 and the first three quarters of
1997, and were settled with the Bank by the placement of approximately $2.7
million into a third party trust. The Bank reclassified the remaining loan
balance of $2.4 million to other assets as of December 31, 1997 and the amount
was substantially collected in 1998.
For the year ended December 31, 1998, interest income that would have been
earned under the original terms of the loans classified in non-accrual and
restructured loans in the above schedule amounted to $494. No interest income
was realized on these loans for 1998. Loans that were considered to be impaired
under SFAS No. 114 totaled $2,367 and $1,864 as of December 31, 1998 and 1997,
respectively, all of which were included in non-performing assets as of those
dates. The related allowance allocated to impaired loans for 1998 and 1997 was
$340 and $1,187, respectively.
8. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires that the Corporation disclose estimated fair values for its financial
instruments. The market value of securities, as presented in Note 5, is based
primarily upon quoted market prices. For substantially all other financial
instruments, the fair values are Management's estimates of the values at which
the instruments could be exchanged in a transaction between willing parties. In
accordance with SFAS No. 107, fair values are based on estimates using present
value and other valuation techniques in instances where quoted prices are not
available. These techniques are significantly affected by the assumptions used,
including discount rates and estimates of future cash flows. As such, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, further, may not be realizable in an immediate
settlement of the instruments. SFAS No. 107 also excludes certain items from its
disclosure requirements. Accordingly, the aggregate fair value amounts presented
do not represent, and should not be construed to represent, the underlying value
of the Corporation.
38
<PAGE> 40
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents the estimates of fair value of financial
instruments:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------ ------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents............................ $49,478 $49,478 $43,354 $43,354
Securities........................................... 354,415 354,415 483,095 481,786
Loans................................................ 970,853 986,236 867,147 861,185
Allowance for loan losses............................ (10,739) (8,826)
Cost of mortgage servicing rights.................... 2,683 2,753 3,752 3,742
Liabilities:
Demand deposits -- non-interest bearing.............. 115,624 115,624 113,175 113,175
Demand deposits -- interest bearing.................. 101,080 101,080 90,340 90,340
Savings deposits..................................... 274,728 274,728 268,033 268,033
Time deposits........................................ 611,158 621,081 643,496 646,733
Federal funds purchased and securities sold under
agreements to repurchase.......................... 122,482 122,482 131,127 131,127
Other borrowed funds................................. 861 861 3,492 3,492
FHLB advances........................................ 72,782 72,383 58,403 58,065
Off-balance sheet:
Interest rate caps................................... 228
</TABLE>
Fair value estimates, methods, and assumptions are set forth below for the
Corporation's financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and cash equivalents approximate those assets' fair value.
Securities: Fair values for securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments.
Loans: Variable-rate loans that reprice frequently are assumed to have a
short-duration period, yielding a fair value that approximates the carrying
value. The fair values for other loans are estimated using a discounted cash
flow calculation.
Cost of mortgage servicing rights: The fair value for the cost of mortgage
servicing rights as of December 31, 1998 were determined via an independent
quote from a third party. The fair values as of December 31, 1997 were
established using discounted cash flows. Included in the valuation of fair value
were assumptions regarding prepayment speeds, discount rates, servicing costs,
delinquency, ancillary income, and foreclosure costs which were arrived at from
third party sources and internal historical records.
Deposit liabilities: The fair values disclosed for demand deposits, insured
money market and interest checking accounts, and savings accounts are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). The carrying amounts for time deposits are estimated
using a discounted cash flow calculation. Variable-rate time deposits that
reprice frequently are assumed to have a short-duration period, yielding a fair
value that approximates the carrying value.
39
<PAGE> 41
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Federal funds purchased, securities sold under agreements to repurchase,
and other short-term borrowings: The carrying amounts of federal funds
purchased, securities sold under agreements to repurchase, and other short-term
borrowings approximate their fair values.
As of December 31, 1997, the Corporation had no outstanding off-balance
sheet instruments requiring fair value disclosure.
9. PREMISES AND EQUIPMENT
The following is a summary of bank premises and equipment accounts as of
December 31:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Land and buildings....................................... $ 5,486 $ 7,840
Leasehold improvements................................... 8,570 5,233
Furniture and equipment.................................. 20,223 17,139
------- -------
34,279 30,212
Less:
Accumulated depreciation and amortization................ 17,160 15,251
------- -------
$17,119 $14,961
======= =======
</TABLE>
10. FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Corporation has available to it the ability to borrow in excess of $37
million from correspondent banks as overnight federal funds purchased. There
were no federal funds purchased at December 31, 1998, 1997, or 1996. The
Corporation has repurchase agreements with corporate customers and local
municipalities. These borrowings have an overnight maturity and are
collateralized with U. S. Treasury and government agency securities, including
agency-issued mortgage-backed securities with a market value of $101,832 and
$127,496 as of December 31, 1998 and 1997, respectively. The securities are held
in the Corporation's safekeeping account at the Federal Reserve Bank. The
Corporation also maintains repurchase agreements with approved brokers and are
collateralized by U. S. Treasury and government agency securities held by the
broker. The following table summarizes certain information relative to these
borrowings:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Outstanding at December 31............................... $122,482 $131,127 $ 86,786
Weighted-average interest rate at December 31............ 4.23% 4.67% 4.31%
Maximum amount outstanding as of any month end........... $166,043 $138,830 $125,089
Average amount outstanding............................... $135,259 $124,652 $ 96,320
Approximate weighted-average interest rate during the
year................................................... 4.61% 4.78% 4.46%
</TABLE>
11. OTHER BORROWED FUNDS AND FEDERAL HOME LOAN BANK ADVANCES
The Corporation has a Treasury Note Option Agreement with the Federal
Government which allows the Corporation to hold funds deposited by customers for
treasury and tax payments to the Government up to a self-imposed limit of
$6,000,000. Federal Home Loan Bank (FHLB) advances are collateralized by all
shares of FHLB stock and a portion of the Corporation's qualified mortgage loan
portfolio, and are used to fund mortgage
40
<PAGE> 42
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
loan originations of the Corporation and as a regular funding source. The detail
of these borrowings on December 31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
CURRENT DECEMBER 31
INTEREST ------------------
DESCRIPTION RATES 1998 1997
----------- --------------- ------- -------
<S> <C> <C> <C>
Treasury note option account.......................... 4.06% $ 861 $ 3,492
Fixed rate FHLB advances with monthly interest
payments Advance due in 1999........................ 5.15% and 5.67% $17,000 $ 3,000
Fixed rate FHLB advances with monthly principal and
interest
payments
Advances due 2000 to 2007........................... 4.93% to 6.95% $55,782 $10,838
Variable rate FHLB advances with monthly principal and
interest payments
Advances due 1999................................... $ 0 $15,000
Fixed rate FHLB advances and borrowings with monthly
principal and interest payments
Advances due 1997 and 1998.......................... $ 0 $29,565
</TABLE>
As of December 31, 1998, the Corporation has available a total of $15
million in unsecured lines of credit with two correspondent banks. The lines are
renewable annually and bear interest at a floating rate based on several indices
including LIBOR, Federal funds, or prime rate.
12. SHAREHOLDERS' EQUITY
On June 25 and July 7, 1993, the Corporation issued a total of 718,750
shares of $1.50 Cumulative Convertible Preferred Stock, Series A-1 (the
"preferred stock"), generating net proceeds of $13,235,000. During 1995 and
1996, the majority of holders converted their shares of preferred stock to
common stock at a rate of 2.2354 shares of common stock for each share of
preferred stock. A nominal number of shares were redeemed for cash.
Dividends are paid by the Corporation from its assets, which are mainly
provided by dividends from the Bank. However, certain restrictions exist
regarding the ability of the Bank to transfer funds to the Corporation in the
form of cash dividends, loans, or advances. The approval of the Comptroller of
the Currency is required to pay dividends in excess of the Bank's earnings
retained in the current year plus retained net profits from the preceding two
years. As of December 31, 1998, the Bank had retained earnings of $78,958, of
which $8,573 was available for distribution to the Corporation as dividends
without prior regulatory approval.
On February 27, 1998, the Board of Directors rescinded the authorization to
repurchase any shares of common stock. As of December 31, 1998, the Corporation
had 50,400 shares held in treasury.
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Corporation's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Corporation and the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Corporation's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of Total and Tier I capital (as defined
41
<PAGE> 43
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
by the regulations) to risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes, as of December
31, 1998, that the Corporation and the Bank meet all capital adequacy
requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Office of
the Comptroller of the Currency categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that Management believes have changed the Bank's
category.
The consolidated Corporation's and the subsidiary Bank's actual capital
amounts and ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE WELL-CAPITALIZED
UNDER
FOR CAPITAL PROMPT CORRECTIVE
ADEQUACY PURPOSES ACTION PROVISIONS
ACTUAL ------------------ -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- ----- --------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total capital (to risk-weighted
assets):
Second Bancorp....................... $127,967 13.5% * $75,573 *8.0% n/a
Second National Bank................. 120,914 12.8 * 75,421 *8.0 *$94,276 *10.0%
Tier I capital (to risk-weighted
assets):
Second Bancorp....................... 117,228 12.4 * 37,787 *4.0 n/a
Second National Bank................. 102,295 10.9 * 37,710 *4.0 * 56,565 * 6.0
Tier I leverage:
Second Bancorp....................... 117,228 8.2 * 57,091 *4.0 n/a
Second National Bank................. 102,295 7.0 * 58,263 *4.0 * 72,829 * 5.0
As of December 31, 1997:
Total capital (to risk-weighted
assets):
Second Bancorp....................... 121,916 13.6 * 71,847 *8.0 n/a
Second National Bank................. 116,560 13.0 * 71,664 *8.0 * 89,580 *10.0
Tier I capital (to risk-weighted
assets):
Second Bancorp....................... 113,174 12.6 * 35,923 *4.0 n/a
Second National Bank................. 98,578 11.0 * 35,832 *4.0 * 53,748 * 6.0
Tier I leverage:
Second Bancorp....................... 113,174 7.9 * 57,000 *4.0 n/a
Second National Bank................. 98,578 6.9 * 56,935 *4.0 * 71,169 * 5.0
</TABLE>
- -----------------
* Denotes greater than or equal to
42
<PAGE> 44
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Numerator:
Net income........................................ $ 5,633 $ 13,236 $ 9,669
Preferred stock dividends......................... 0 0 (456)
----------- ----------- -----------
Numerator for basic earnings per share -- income
available to common stockholders............... 5,633 13,236 9,213
Effect of dilutive securities:
Preferred stock dividends...................... 0 0 456
----------- ----------- -----------
Numerator for diluted earnings per share -- income
available to common stockholders after assumed
conversions.................................... $ 5,633 $ 13,236 $ 9,669
=========== =========== ===========
Denominator:
Denominator for basic earnings per share --
weighted-average shares........................ 10,665,597 10,555,921 9,876,174
Effect of dilutive securities:
Employee stock options......................... 77,025 60,831 57,154
Preferred stock................................ 0 0 621,732
----------- ----------- -----------
Dilutive potential common shares.................. 77,025 60,831 678,886
----------- ----------- -----------
Denominator for diluted earnings per
share -- adjusted weighted-average shares and
assumed conversions.......................... 10,742,622 10,616,752 10,555,060
=========== =========== ===========
Basic earnings per share............................ $ .53 $ 1.25 $ .93
=========== =========== ===========
Diluted earnings per share.......................... $ .52 $ 1.25 $ .92
=========== =========== ===========
</TABLE>
14. FEDERAL INCOME TAXES
The Corporation's federal income tax provision in the accompanying
statements of income differs from the statutory rate as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------- -------
<S> <C> <C> <C>
Statutory rate.............................................. 34% 34% 34%
Income before federal income taxes.......................... $7,036 $16,981 $12,662
Tax at statutory rate....................................... $2,392 $ 5,774 $ 4,305
Tax effect of non-taxable interest.......................... (1,388) (1,187) (1,001)
Merger costs................................................ 603 0 0
Other items, net............................................ (204) (842) (311)
------ ------- -------
$1,403 $ 3,745 $ 2,993
====== ======= =======
</TABLE>
43
<PAGE> 45
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Corporation's deferred tax liabilities and
assets as of December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Deferred tax liabilities:
SFAS No. 115 adjustment................................ $1,576 $1,561
FHLB dividends......................................... 1,198 908
Other.................................................. 1,168 552
------ ------
Total deferred tax liabilities.................... 3,942 3,021
Deferred tax assets:
Provision for loan losses.............................. 3,222 2,344
Goodwill and intangible amortization................... 711 811
Non-accrual interest................................... 528 634
Other.................................................. 1,458 1,085
------ ------
Total deferred tax assets......................... 5,919 4,874
------ ------
Net deferred tax assets..................................... $1,977 $1,853
====== ======
</TABLE>
15. EMPLOYEE BENEFIT PLANS
The Corporation has a non-contributory, defined-benefit pension plan
covering substantially all of its employees. The benefits are based on a
percentage of the employee's average annual earnings multiplied by completed
years of continuous service. The Corporation's funding policy is to contribute
annually an amount between the minimum required and the maximum amount that can
be deducted for federal income tax purposes. Contributions are intended to
provide not only for benefits attributed to service to date but also for those
expected to be earned in the future. The plan assets at December 31, 1998 are
invested primarily in common stock, preferred stock, and corporate bonds. The
Bank also has a supplemental retirement deferred benefit plan for certain
employees, which provides benefits in excess of the defined benefit plan.
44
<PAGE> 46
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the plan's pension benefits as of December
31:
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of year..................... $ 6,024 $5,010
Service cost................................................ 571 524
Interest cost............................................... 447 368
Actuarial loss.............................................. 725 238
Disbursements............................................... (95) (116)
------- ------
Benefit obligation at end of year........................... $ 7,672 $6,024
======= ======
Change in plan assets:
Fair value of plan assets at beginning of year.............. $ 6,979 $5,864
Actual return on plan assets................................ 1,823 1,218
Disbursements............................................... (95) (103)
------- ------
Fair value of plan assets at end of year.................... $ 8,707 $6,979
======= ======
Funded status............................................... $ 1,035 $ 954
Unrecognized net actuarial gain............................. (2,092) (1,591)
Unrecognized prior service cost............................. 18 25
Unrecognized initial net obligation......................... (92) (114)
------- ------
Net amount recognized....................................... $(1,131) $ (726)
======= ======
Accrued benefit liability recognized........................ $(1,131) $ (726)
======= ======
Weighted-average assumptions as of December 31:
Discount rate............................................... 6.88% 7.25%
Expected return on plan assets.............................. 9.75% 9.75%
Age- Age-
Rate of compensation increase(1)............................ graded graded
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Components of net periodic benefit cost:
Service cost.............................................. $571 $524 $560
Interest cost............................................. 447 368 443
Expected return on plan assets............................ (594) (531) (494)
Amortization of prior service cost........................ 6 11 29
Amortization of initial net asset......................... (22) (20) (16)
Recognized net actuarial gain............................. (4) (18) 44
---- ---- ----
Net periodic pension expense.............................. $404 $334 $566
==== ==== ====
</TABLE>
- ---------------
(1) A 5% rate of compensation increase was assumed for the nonqualified plan.
The projected benefit obligation, accumulated benefit obligation, and fair
value of plan assets for the nonqualified pension plan with accumulated benefit
obligations in excess of plan assets were $737, $737, and $0, respectively, as
of December 31, 1998, and $546, $445, and $0, respectively as of December 31,
1997.
45
<PAGE> 47
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Prior to its acquisition, Trumbull had a noncontributory defined benefit
retirement plan covering substantially all of its employees. The plan was a
multi-employer plan and separate actuarial valuations were not made with respect
to each employer, nor were plan assets so segregated. The multi-employer plan
still covers the benefit obligation for the former Trumbull employees who are
now employed by the Corporation. Amounts contributed to the plan were $0, $71,
and $79 in 1998, 1997, and 1996, respectively.
The Bank also has a stock appreciation rights plan that was used to grant
certain officers stock appreciation rights upon their employ. The Corporation
has not issued any rights since 1987. As of December 31, 1998 and 1997, the
accumulated obligation for these rights recorded in the financial statements was
$168 and $394, respectively. The plan expense for 1998, 1997, and 1996 was $56,
$190, and $9, respectively.
The Bank also sponsors a defined contribution benefit plan covering
substantially all eligible employees of the Bank. The Bank voluntarily
contributes 75% of the participants' contribution to a maximum of 4.5% of the
participant's compensation. Participants, at their discretion, may invest in
several investment funds or a stock fund consisting solely of the Corporation's
common stock. The Bank's contribution is limited solely to the stock fund.
Contributions in 1998, 1997, and 1996 were $410, $395, and $360, respectively.
The Board of Directors of the Corporation has authorized the issuance of 99,000
shares of the Corporation's common stock for use in the Bank's defined
contribution benefit plan. As of December 31, 1998, none of the shares
authorized have been issued.
16. STOCK OPTIONS
The Corporation maintains incentive and non-qualified stock option plans
that allow for stock based awards to eligible employees and directors. Through
February 1998, the Corporation issued incentive stock options that were
exercisable in one year after issuance and expire after 10 years. The maximum
annual grant was 7,500 shares per employee. The plan was terminated in May 1998
when the non-qualified stock option plan was approved. The non-qualified plan
authorizes 650,000 shares of common stock to be reserved and subject to
issuance. The maximum annual grant is 10,000 shares per employee and 1,000
shares per director. The options are also exercisable one year after issuance
and expire after 10 years.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, "Accounting for Stock-Based Compensation" and has been
determined as if the Corporation had accounted for its employee stock options
under the fair-value method of that Statement. Under the fair-value based
method, compensation cost is measured at the grant date based upon the value of
the award and recognized over the service period. The Corporation has elected,
as the standard allows, to continue to measure compensation costs for its plans
as prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees" because the alternative fair value accounting
provided under SFAS No. 123 requires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB No. 25,
because the exercise price of the Corporation's employee stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized. Pro forma disclosure of net income and earnings per share
is made in the accompanying footnotes as if the fair-value method of accounting,
as defined by SFAS No. 123, had been adopted.
46
<PAGE> 48
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Risk-free interest rate........................... 4.6% 5.5% 6.0%
Dividend yield.................................... 3.0% 3.0% 3.0%
Volatility factor of expected market price of
Corporation's common stock...................... .214 .161 .137
Weighted-average expected life.................... 6 years 6 years 6 years
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Corporation's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in Management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Corporation's pro forma information follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Pro forma net income............................. $ 5,447 $13,112 $ 9,590
Pro forma earnings per share:
Basic.......................................... $ .51 $ 1.24 $ .92
Diluted........................................ $ .51 $ 1.24 $ .91
</TABLE>
Due to the inclusion of only 1996, 1997, and 1998 option grants, the
effects of applying SFAS No. 123 to the years presented above may not be
representative of the pro forma impact in future years.
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES OPTION PRICE PER SHARE TOTAL
---------------- ---------------------- ------
<S> <C> <C> <C>
Outstanding at December 31, 1995............... 173,200 $ 4.33 - $10.58 $1,666
Granted...................................... 63,300 13.44 850
Exercised.................................... (29,700) 7.33 - 10.58 (275)
------- --------------- ------
Outstanding at December 31, 1996............... 206,800 4.33 - 13.44 2,241
Granted...................................... 62,000 22.13 - 24.19 1,380
Exercised.................................... (75,400) 4.33 - 13.44 (716)
------- --------------- ------
Outstanding at December 31, 1997............... 193,400 7.33 - 24.19 2,905
Granted...................................... 114,200 23.88 - 25.44 2,860
Exercised.................................... (31,150) 10.56 - 13.44 (377)
------- --------------- ------
Outstanding at December 31, 1998............... 276,450 $ 7.33 - $25.44 $5,388
======= =============== ======
Exercisable at December 31, 1998............... 162,250 $ 7.33 - $24.19 $2,528
</TABLE>
The weighted-average fair value of the options granted during 1998, 1997,
and 1996 were $5.41, $4.05, and $4.80, respectively. The weighted-average
remaining contractual life of the outstanding options is 8.3 years.
47
<PAGE> 49
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. PARENT COMPANY
Condensed financial information of Second Bancorp, Inc. (Parent Company
only) is as follows:
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1998 1997
-------- -------
<S> <C> <C>
Assets:
Cash...................................................... $ 3,685 $ 2,180
Available-for-sale securities............................. 1,708 1,632
Loans..................................................... 661 683
Investment in and advances to subsidiary, at equity in
underlying value of their net assets................... 119,154 79,756
Fixed assets.............................................. 74 43
Other assets.............................................. 3,195 1,012
-------- -------
Total assets...................................... $128,477 $85,306
======== =======
Liabilities and Shareholders' Equity:
Accrued and other liabilities............................. $ 5,204 $ 1,562
Note payable.............................................. 0 65
Shareholders' Equity:
Preferred stock, no par value;
Series A: 1,500,000 shares authorized in 1997;
718,750 shares issued and 0 shares outstanding...... 0
Series B: 1,500,000 shares authorized in 1997........ 0
Common stock, no par value; 20,000,000 shares authorized;
10,738,850 and 10,657,149 shares issued,
respectively........................................... 36,901 34,485
Treasury stock, 50,400 shares............................. (793) (793)
Net unrealized holding gains on available-for-sale
securities............................................. 3,097 3,021
Retained earnings......................................... 84,068 46,966
-------- -------
Total Liabilities and Shareholders' Equity........ $128,477 $85,306
======== =======
</TABLE>
48
<PAGE> 50
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
---------------------------
1998 1997 1996
------ ------- ------
<S> <C> <C> <C>
Income:
Cash dividends from subsidiary............................ $8,767 $ 7,722 $8,384
Interest income........................................... 1,000 865 752
Gains on sale of securities............................... 41 352 0
Other income.............................................. 32 26 19
------ ------- ------
Total income................................................ 9,840 8,965 9,155
Expenses:
Interest expense.......................................... 0 276 371
Merger costs.............................................. 6,657 0 0
Other expenses............................................ 1,162 1,700 563
------ ------- ------
Total expenses.............................................. 7,819 1,976 934
------ ------- ------
Income before income taxes and equity in undistributed
earnings of subsidiary.................................... 2,021 6,989 8,221
Income tax benefit.......................................... 1,777 429 60
Income before equity in undistributed earnings of
subsidiary................................................ 3,798 7,418 8,281
Equity in undistributed earnings of subsidiary.............. 1,835 5,818 1,388
------ ------- ------
Net income................................................ $5,633 $13,236 $9,669
====== ======= ======
</TABLE>
49
<PAGE> 51
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Operating Activities:
Net income................................................ $ 5,633 $13,236 $ 9,669
Less: Equity in undistributed net income of subsidiary.... (1,835) (5,818) (1,388)
Provision for depreciation................................ 31 29 26
Gain on sale of securities................................ (41) (352) 0
Other (net)............................................... 1,444 300 (43)
------- ------- -------
Cash provided by operations................................. 5,232 7,395 8,264
Investing Activities:
Increase in loan to subsidiary............................ 0 (2,000) (2,000)
Net decrease in loans..................................... 22 20 19
Sale of securities........................................ 0 0 300
Purchase of securities.................................... (191) (903) (482)
Donation of securities to charitable foundation........... 202 824 0
Purchase of premises and equipment.......................... (63) (8) (63)
------- ------- -------
Cash used by investing activities........................... (30) (2,067) (2,226)
Financing Activities:
Issuance of note payable.................................. 0 65 0
Repayment of note payable................................. (65) (5,000) 0
Redemption and conversion of preferred stock.............. 0 (2) (32)
Issuance of common stock.................................. 1,547 1,900 571
Purchase of treasury stock................................ 0 (474) (319)
Payment of dividend....................................... (5,155) (3,248) (3,272)
------- ------- -------
Cash used by financing activities........................... (3,673) (6,759) (3,052)
Increase (decrease) in cash................................. 1,529 (1,431) 2,986
Cash at beginning of year................................... 2,156 3,611 625
------- ------- -------
Cash at end of year......................................... $ 3,685 $ 2,180 $ 3,611
======= ======= =======
</TABLE>
Conforming adjustments for the pooled company for the fiscal quarter ending
December 31, 1997 included $244, $0, and $(268) for operating, investing, and
financing activities, respectively.
18. OFF-BALANCE SHEET INSTRUMENTS
The Corporation utilizes off-balance sheet financial instruments,
frequently called interest rate derivatives, to efficiently manage its exposure
to interest rate risk. As with any financial instrument, derivatives have
inherent risks. Market risk includes the risk of gains and losses that result
from changes in interest rates. These gains and losses may be offset by other
on- or off-balance sheet transactions. Credit risk is the risk that the
counter-party fails to perform according to the terms of the contract. Credit
risk can be measured as the cost of acquiring a new derivative contract with
identical cash flows as those of the defaulted agreement.
The Corporation uses interest rate cap contracts to help protect its net
interest margin in periods of extremely high interest rates. As of December 31,
1998, the Corporation's interest rate cap contracts used for interest rate risk
management purposes had a notional amount of $30,900, unrealized loss of $228,
an average strike rate of 6.0%, and an average life of 3.3 years.
50
<PAGE> 52
SECOND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. COMMITMENTS AND CONTINGENT LIABILITIES
Loan Commitments:
Loan commitments are made to accommodate the financial needs of the Bank's
customers; however, there are no long-term, fixed-rate loan commitments that
result in market risk. Standby letters of credit commit the Bank to make
payments on behalf of customers when certain specified future events occur. They
primarily are issued to facilitate customers' trade transactions.
Both arrangements have credit risk, essentially the same as that involved
in extending loans to customers, and are subject to the Bank's normal credit
policies. Collateral (e.g., securities, receivables, inventory, and equipment)
is obtained based on Management's credit assessment of the customer.
The Bank's maximum obligation to extend credit for loan commitments
(unfunded loans and unused lines of credit) and standby letters of credit
outstanding on December 31 was as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Commercial.............................................. $111,897 $ 99,726
Real Estate............................................. 9,054 12,669
Consumer................................................ 32,563 21,634
Standby Letters of Credit............................... 4,428 13,833
-------- --------
$157,942 $147,862
======== ========
</TABLE>
Lease Agreements:
The Bank has entered into lease agreements covering its main office,
several branch locations, and equipment for various periods through 2011, with
options to renew. Also, the Bank has the option to purchase the main office
facility before two optional renewal periods at the fair market value in
existence at that time.
Future minimum commitments under non-cancelable operating leases are as
follows:
<TABLE>
<S> <C>
1999............................................. $2,062
2000............................................. 2,014
2001............................................. 1,920
2002............................................. 1,806
2003............................................. 1,702
Thereafter....................................... 9,036
</TABLE>
Rentals under operating leases and data processing costs amounted to
$3,501, $2,762, and $3,163 in 1998, 1997, and 1996, respectively.
Low Income Housing Project: In 1993, the Bank began investing in low-income
housing tax credit projects designed to provide affordable housing for Ohio
communities. The Bank has invested $1,061 to date and has begun to realize tax
credits and tax savings from the investments. The Bank is committed to invest
another $439 to the fund over the next several years.
20. SIGNIFICANT CONCENTRATION OF CREDIT RISK
Most of the Bank's business activity is with customers located within the
state of Ohio. As of December 31, 1998, the Bank had a concentration in
commercial real estate loans totaling approximately $258,000, approximately
68.5% of which were owner-occupied businesses, including medical office
buildings, retail, and fast-food restaurants within the Bank's market area. Of
the $258,000 of commercial real estate loans, $3,453 or 1.3% were on non-accrual
status as of December 31, 1998.
51
<PAGE> 53
SECOND BANCORP, INC. AND SUBSIDIARY
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF SECOND BANCORP, INC.
We have audited the accompanying consolidated balance sheets of Second
Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Corporation's Management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
Management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Second Bancorp,
Inc. and subsidiary at December 31, 1998 and 1997, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Cleveland, Ohio
January 26, 1999
52
<PAGE> 54
SECOND BANCORP, INC. AND SUBSIDIARY
SUPPLEMENTARY DATA -- UNAUDITED QUARTERLY RESULTS OF OPERATIONS
DECEMBER 31, 1998
The following is a summary of the quarterly results of operations for the
years ended December 31, 1998 and 1997. The financial data contained therein has
been restated to reflect the pooling-of-interests business combinations (see
Note 3). Per share data was retroactively restated for a two-for-one stock split
effective May 1, 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31
-------- -------- --------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1998
Interest income.................................... $27,113 $27,166 $26,811 $25,907
Interest expense................................... 14,224 14,300 14,121 13,243
Net interest income................................ 12,889 12,866 12,690 12,664
Provision for loan losses.......................... 859 881 1,951 6,888
Other income....................................... 2,486 2,860 3,356 3,045
Security gains (losses)............................ 128 35 850 (6)
Other expenses..................................... 9,646 10,178 10,915 15,509
Income before federal income taxes................. 4,998 4,702 4,030 (6,694)
Federal income taxes............................... 1,333 1,317 1,195 (2,442)
Net income......................................... 3,665 3,385 2,835 (4,252)
Earnings per common share:
Basic............................................ $ 0.34 $ 0.32 $ 0.27 $ (0.40)
Diluted.......................................... $ 0.34 $ 0.32 $ 0.26 $ (0.40)
1997
Interest income.................................... $25,363 $26,041 $26,565 $27,021
Interest expense................................... 13,463 13,698 14,233 14,313
Net interest income................................ 11,900 12,343 12,332 12,708
Provision for loan losses.......................... 816 826 1,110 1,453
Other income....................................... 2,489 2,607 2,719 2,771
Security gains (losses)............................ 31 16 386 82
Other expenses..................................... 9,565 10,008 10,001 9,624
Income before federal income taxes................. 4,039 4,132 4,326 4,484
Federal income taxes............................... 1,033 951 1,087 674
Net income......................................... 3,006 3,181 3,239 3,810
Earnings per common share:
Basic............................................ $ 0.29 $ 0.30 $ 0.30 $ 0.36
Diluted.......................................... $ 0.29 $ 0.30 $ 0.30 $ 0.36
</TABLE>
53
<PAGE> 55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
In accordance with General Instruction G(3), the information called for in
this Item 10 is incorporated herein by reference to Second Bancorp's definitive
proxy statement for the annual meeting of shareholders to be held May 11, 1999
(the "Proxy Statement"). Such Proxy Statement will be filed with the Securities
and Exchange Commission within 120 days of December 31, 1998. Information
regarding executive officers is included under item 4a hereof.
ITEM 11. EXECUTIVE COMPENSATION
In accordance with General Instruction G(3), the information called for in
this Item 11 is incorporated herein by reference to Second Bancorp's definitive
proxy statement for the annual meeting of shareholders to be held May 11, 1999
(the "Proxy Statement"). Such Proxy Statement will be filed with the Securities
and Exchange Commission within 120 days of December 31, 1998. Information
regarding executive officers is included under item 4a hereof.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
In accordance with General Instruction G(3), the information called for in
this Item 12 is incorporated herein by reference to Second Bancorp's definitive
proxy statement for the annual meeting of shareholders to be held May 11, 1999
(the "Proxy Statement"). Such Proxy Statement will be filed with the Securities
and Exchange Commission within 120 days of December 31, 1998. Information
regarding executive officers is included under item 4a hereof.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In accordance with General Instruction G(3), the information called for in
this Item 13 is incorporated herein by reference to Second Bancorp's definitive
proxy statement for the annual meeting of shareholders to be held May 11, 1999
(the "Proxy Statement"). Such Proxy Statement will be filed with the Securities
and Exchange Commission within 120 days of December 31, 1998. Information
regarding executive officers is included under item 4a hereof.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) The following consolidated financial statements of Second Bancorp,
Incorporated and its subsidiary are included in Item 8:
Consolidated Balance Sheets -- December 31, 1998 and 1997.
Consolidated Statements of Income -- years ended December 31, 1998, 1997
and 1996.
Consolidated Statements of Shareholders' Equity -- years ended December 31,
1998, 1997 and 1996.
Consolidated Statement of Cash Flows -- years ended December 31, 1998, 1997
and 1996.
Notes to Consolidated Financial Statements.
Report of Independent Auditors.
54
<PAGE> 56
(2) Schedules to the consolidated financial statements required by Article
9 of Regulation S-X are not required under the related instructions or are
inapplicable, and therefore have been omitted.
(3) Listing of Exhibits. The exhibits listed on the accompanying Index to
Exhibits immediately following the financial statement schedules are filed
as part of, or incorporated by reference into, this report.
<TABLE>
<C> <S> <C>
3.1 Amended and Restated Articles of Incorporation of the
Registrant. (As updated to include Amendments dated March
17, 1987; January 7, 1991; June 20, 1997; September 18,
1998; and November 10, 1998)
3.3 (1) Code of Regulations of the Registrant.
10.1 (2) 1998 Non-qualified Stock Option Plan
10.1 (1) Amended Stock Option Incentive Plan.
10.2 (1) Form of Incentive Stock Option Agreement.
10.3 (1) Stock Appreciation Rights Agreement by and between Second
Bancorp and Alan G. Brant, dated April 1, 1987, as amended.
10.4 (3) Form of Amendment to April 1, 1987 Stock Appreciation Rights
Agreement by and between Second Bancorp and Alan G. Brant,
effective December 18, 1996.
10.5 (1) Employment Agreement by and between Second Bancorp and Alan
G. Brant, dated April 1, 1985.
10.6 (4) Amendments to Employment Agreement by and between Second
Bancorp and Alan G. Brant, dated April 1, 1985.
10.7 (1) Consulting Agreement by and between Second Bancorp and Alan
G. Brant, dated April 1, 1985.
10.8 (4) Amendment to Consulting Agreement by and between Second
Bancorp and Alan G. Brant, dated April 1, 1985.
10.9 (4) Deferred Compensation Agreement between Second Bancorp and
Alan G. Brant, dated November 9, 1995.
10.10 (1) Lease Agreement between Arden Associates Limited Partnership
and Second National, dated October 1, 1979.
10.11 (4) Amendment to Lease Agreement between Arden Associates
Limited Partnership and Second National.
10.12 (4) Form of Amended Management Severance Agreement with
executive officers.
10.13 (5) Revolving Credit Agreement (excluding exhibits), dated
September 15, 1998, between Second Bancorp and The Northern
Trust Company.
10.14 (5) First Amendment to Revolving Credit Agreement (excluding
exhibits), dated March 11, 1997, between Second Bancorp and
The Northern Trust Company.
10.15 Form of Non-qualified Stock Option Agreement.
11 (6) Statement Re: Computation of Per Share Earnings
21 Subsidiaries of the registrant.
23.1 Consent of Ernst & Young.
27 Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference to the exhibit filed with Second
Bancorp's annual report on Form 10-K for the year ended December
31, 1994.
(2) Incorporated by reference to Exhibit A of the Registrant's proxy
statement dated April 1, 1998, as filed with the Securities and
Exchange Commission in April, 1998.
(3) Incorporated by reference to the exhibit filed with Second
Bancorp's annual report on Form 10-K for the year ended December
31, 1997.
55
<PAGE> 57
(4) Incorporated by reference to the exhibit filed with Second
Bancorp's annual report on Form 10-K for the year ended December
31, 1995.
(5) Incorporated by reference to the Exhibit filed with the
Registrant's registration statement on Form S-4 (registration No.
333-62365) as filed on September 21, 1998 with the Securities and
Exchange Commission.
(6) Page 43 (Included in Note 13 of the Notes to the Consolidated
Financial Statements of Registrant in the financial statements
portion of this annual report on Form 10-K.)
(b) The Corporation filed three reports on Form 8-K during the three months
ended December 31, 1998. A Form 8-K was filed on November 27, 1998 to
disclose the completion of the acquisition of Trumbull Financial Corporation
on November 20, 1998. A Form 8-K was filed on November 27, 1998 to disclose
the election of Dr. David A. Allen, Jr. as a director of Second Bancorp
Incorporated. A Form 8-K was filed on December 22, 1998 to disclose the
extension of the employment agreement of Chairman and President Alan G.
Brant for an additional two-year term.
(c) Exhibits -- The response to this portion of Item 14 is included at Item
14(a)(3) of this report.
(d) Financial Statement Schedules -- None.
56
<PAGE> 58
SIGNATURES
Pursuant to the requirements of section 13 or 15 (d) 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.
SECOND BANCORP, INCORPORATED
/s/ DAVID L. KELLERMAN March 25, 1999
--------------------------------------
David L. Kellerman,
Treasurer (date)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
<TABLE>
<S> <C>
By: /s/ ALAN G. BRANT March 25, 1999
- ------------------------------------------------
A. G. Brant, Chairman And President
By: /s/ DAVID L. KELLERMAN March 25, 1999
- ------------------------------------------------
D. L. Kellerman, Principal Financial
Officer and Principal Accounting Officer
By: /s/ ROBERT J. WEBSTER March 26, 1999
- ------------------------------------------------
Robert J. Webster, Director
By: /s/ JAMES R. IZANT March 26, 1999
- ------------------------------------------------
James R. Izant, Director
By: /s/ DAVID A. ALLEN March 26, 1999
- ------------------------------------------------
Dr. David A. Allen, Jr., Director
By: /s/ NORMAN C. HARBERT March 26, 1999
- ------------------------------------------------
Norman C. Harbert, Director
By: /s/ PHYLLIS J. IZANT March 29, 1999
- ------------------------------------------------
Phyllis J. Izant, Director
</TABLE>
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3.1 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF THE REGISTRANT (INCLUDING
AMENDMENTS DATED MARCH 17, 1987; JANUARY 7, 1991; JUNE 20, 1997; SEPTEMBER
18, 1998; AND NOVEMBER 10, 1998)
ARTICLES OF INCORPORATION OF
SECOND BANCORP, INCORPORATED
The undersigned, acting as the incorporator of a corporation for profit
under the general corporation laws of the State of Ohio, adopts the following
Articles of Incorporation:
FIRST: The name of the Corporation shall be Second Bancorp Incorporated.
SECOND: The place in Ohio where its principal office is to be located is at
108 Main Avenue S.W., in the City of Warren, Trumbull County, Ohio, but the
Corporation may establish and maintain its principal office, or other offices,
at other places in the United States of America, as its Board of Directors may
from time to time determine.
THIRD: The purpose for which the Corporation is formed is to engage in
business as a "bank holding company" in accordance with, and to the extent
permitted by, the Bank Holding Company Act of 1956 (Pub. Law 511, 84th Cong. 2d
Sess., approved May 9th, 1956) as amended, and consistent therewith to engage in
any other lawful act or activity for which corporations may be formed under
Chapter 1701 of the Ohio Revised Code, to the extent that such act or activity
is not then prohibited by the Bank Holding Company Act of 1956, as amended. The
Corporation may from time to time, pursuant to authorization by the Board of
Directors and without action by the shareholders, purchase or otherwise acquire
shares of the Corporation of any class or classes in such manner, upon such
terms and in such amounts as the Board of Directors shall determine; subject,
however, to such limitation or restriction, if any, as is contained in the
express terms of any class of shares of the Corporation outstanding at the time
of the purchase or acquisition in question.
FOURTH: The maximum number of capital shares which this Corporation is
authorized to issue or to have outstanding at any time shall be twenty million
(20,000,000) shares, all of which shall be common shares. The shares will have
no par value stated. The Board of directors of the Corporation is hereby
empowered to issue from time to time shares of its capital shares, whether now
or hereafter authorized. No holders of any class of shares of the Corporation
shall have any preemptive rights to purchase or to have offered to them for
purchase any shares or other securities of the Corporation.
FIFTH: The amount of stated capital with which this Corporation will begin
business shall be five hundred dollars ($500.00).
SIXTH: (A) The number of directors constituting the Board of Directors
shall be such number, not more than eighteen (18), as shall be fixed from time
to time in accordance with the Regulations of the Corporation and the number so
fixed shall constitute the Board of Directors until the number of directors is
thereafter changed pursuant to the provisions of the Regulations, but the number
thereof shall in no event be less than six (6) and the number of directors in
each class shall in no event be less than three (3).
(B) The Board of Directors shall be and is divided into two classes,
Class I and Class II, which shall be as nearly equal in number as possible.
Each director shall serve for a term ending on the date of the second
annual meeting following the annual meeting at which such director was
elected, provided, however, that each initial director in Class I shall
hold office until the annual meeting of shareholders in 1987; and each
initial director in Class II shall hold office until the annual meeting of
shareholders in 1988.
(C) In the event of any increase or decrease in the authorized number
of directors, (i) each director then serving as such shall nevertheless
continue as a director of the class of which he or she is a member until
the expiration of his or her current term, or his or her prior death,
retirement, resignation or removal and (ii) the newly created or eliminated
directorship resulting from such increase or decrease shall be apportioned
by the Board of Directors among the two classes of directors so as to
maintain such classes as nearly equal as possible.
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(D) Notwithstanding any of the foregoing provisions of this Article
SIXTH, each director shall serve until his or her successor is elected and
qualified or until his or her death, retirement, resignation, or removal.
Should a vacancy occur or be created, whether arising through death,
resignation or removal of a director, or through an increase in the number
of directors of any class, such vacancy shall be filled by a majority vote
of the remaining directors of the class in which such vacancy occurs, or by
the sole remaining director of the class if only one such director remains,
or by the majority vote of the remaining directors of the other class if
there be no remaining member of the class in which the vacancy occurs. A
director so elected to fill a vacancy shall serve for the remainder of the
then present term of office of the class to which he or she was elected.
(E) Wherever the term "Board of Directors" is used in these Articles
of Incorporation, such terms shall mean the Board of Directors of the
Corporation; provided, however, that, to the extent any committee of
directors of the Corporation is lawfully entitled to exercise the powers of
the Board of Directors, such committee, to the extent provided by
resolution of the Board of Directors or the Regulations, may exercise any
power or authority of the Board of Directors under these Articles of
Incorporation in management of the business and affairs of the Corporation,
including without limitation, the declaration of a dividend or the
authorization of the issuance of shares.
SEVENTH: Each person who is or was a director, officer, employee or agent
of the Corporation shall be indemnified by the Corporation to the full extent
permitted by the corporation laws of the State of Ohio, now or hereafter in
force, against any liability, cost or expense incurred by him in his capacity as
a director, officer, employee, or agent, or arising out of his status as a
director, officer, employee, or agent. The corporation may, but shall not be
obligated to maintain insurance at its expense, to protect itself and any such
person against any such liability cost or expense. The rights of indemnification
provided in this Article SEVENTH shall be in addition to any rights to which any
person concerned may otherwise be entitled by the Regulations of the Corporation
from time to time in effect, by contract or as a matter of law, and shall inure
to the benefit of the heirs, executors and administrators of any such person.
EIGHTH: (1) A. In addition to any affirmative vote required by law:
(i) any merger or consolidation of the Corporation or any
Subsidiary (as hereinafter defined) with (a) any Related Person (as
hereinafter defined) or (b) any other corporation (whether or not itself
a Related Person) which is, or after such merger or consolidation would
be, an Affiliate (as hereinafter defined) of a Related Person; or
(ii) any sale, lease, exchange, mortgage, pledge, transfer or other
disposition (in one transaction of a series of transactions) to or with
any Related Person or any Affiliate of any Related Person of any assets
of the Corporation or any Subsidiary having an aggregate Fair Market
Value (as hereinafter defined) equal to 10% or more of the consolidated
net worth of the Corporation; or
(iii) the issuance or transfer by the Corporation or any Subsidiary
(in one transaction or a series of transactions) of any securities of
the Corporation or any Subsidiary to any Related Person or any Affiliate
of any Related Person in exchange for cash, securities or other property
(or a combination thereof) having an aggregate Fair Market Value equal
to 10% or more of the consolidated net worth of the Corporation; or
(iv) the adoption of any plan or proposal for the liquidation or
dissolution of the Corporation; or
(v) any reclassification of securities (including any reverse share
split), or recapitalization of the Corporation, or any merger or
consolidation of the Corporation with any of its Subsidiaries or any
other transaction (whether or not with or into or otherwise involving a
Related Person) which has the effect, directly or indirectly, of
increasing the proportionate share of the outstanding shares of any
class of Equity Security (as hereinafter defined) of the Corporation or
any Subsidiary which is directly or indirectly owned by any Related
Person or any Affiliate of any Related Person, shall require the
affirmative vote of the holders of at least 75% of the voting power of
the then outstanding shares of capital shares of the Corporation
entitled to vote generally in the election of directors. Such
affirmative
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vote shall be required notwithstanding the fact that no vote may be
required or that a lesser percentage may be specified, by law or
otherwise.
B. The term "Business Combination" used in this Article EIGHTH
shall mean any transaction which is referred to in any one or more of
clauses (i) through (v) of paragraph A of this Section.
(2) Notwithstanding the requirements of the previous Section, no Business
Combination between the Corporation (or any Subsidiary) and a Related Person or
any Affiliate of a Related Person may be effected unless all of the following
conditions are met:
A. The aggregate amount of the cash and the Fair Market Value as of
the date of the consummation of the Business Combination of consideration
other than cash to be received per share by holders of any class of Equity
Security in such Business Combination shall be at least equal to the
highest per share price (including any brokerage commissions, transfer
taxes and soliciting dealer's fees) paid by the Related Person for any
shares of the same class of Equity Security previously acquired by it, plus
interest on such amount compounded annually from the date that the Related
Person became a Related Person (the "Determination Date") through the date
of consummation of the Business Combination (the "Consummation Date") at
the rate publicly announced as the "Prime Rate" of interest (announced by
such major bank as may be selected by a majority of the Continuing
Directors), from time to time in effect, less the aggregate amount of any
cash dividends paid and the Fair Market Value of any dividends paid in
other than cash on each share from the Determination Date through the
Consummation Date, up to, but not exceeding, the amount of interest payable
per share.
B. The consideration to be received by holders of a particular class
of Equity Security shall, except to the extent a shareholder agrees
otherwise, be in cash or in the same form as the Related Person has
previously paid for shares of such class of Equity Security. If the Related
Person has paid for shares of any class of Equity Security with varying
forms of consideration, the form of consideration for such class of Equity
Security shall be either cash or in the form used to acquire the largest
number of shares of such class of Equity Security previously acquired by
it. The price determined in accordance with paragraph A of this Section
shall be subject to appropriate adjustment in the event of any share
dividend, share split, combination of shares or similar event.
(3) The provisions of Sections (1) and (2) of this Article EIGHTH shall not
apply to a Business Combination if:
A. The Continuing Directors of the Corporation by a two-thirds vote
(i) have expressly approved a memorandum of understanding with the Related
Person with respect to the Business Combination prior to the time that the
Related Person became a Related Person and the Business Combination is
effected on substantially the same terms and conditions as are provided by
the memorandum of understanding, or (ii) have otherwise approved the
Business Combination (this provision is incapable of satisfaction unless
there is at least one Continuing Director); or
B. The Business Combination is solely between the Corporation and
another corporation, one hundred percent of the Voting Shares of which is
owned directly or indirectly by the Corporation.
In the event the Continuing Directors shall approve a Business
Combination as set forth in paragraph A above, or the Business Combination
is solely between the Corporation and another corporation described in
paragraph B above, such Business Combination shall require only such
shareholder vote, if any, as is required by law.
(4) For the purpose of this Article EIGHTH:
A. "Person" shall mean any individual, firm, corporation or other
entity.
B. "Related Person" shall mean any Person who or which:
(i) is the beneficial owner, directly or indirectly, of 10% or more
of the voting power of the outstanding Voting Shares; or
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(ii) is an Affiliate or Associate of the Corporation and at any
time within the two-year period immediately prior to the date in
question was the beneficial owner, directly or indirectly, of 10% or
more of the voting power of the then outstanding Voting Shares; or
(iii) is an assignee of or has otherwise succeeded to any shares of
Voting Shares which were at any time within the two-year period
immediately prior to the date in question beneficially owned by any
Related Person, if such assignment or succession shall have occurred in
the course of a transaction or series of transactions not involving a
public offering within the meaning of the Securities Act of 1933, as
amended.
Provided, however, that the term "Related Person" shall not include
(i) the Corporation or any Subsidiary, (ii) any one or any group of the
Continuing Directors, or (iii) any profit-sharing, employee shares
ownership or other employee benefit plan of the corporation or any
Subsidiary of the Corporation or any trustee of or other fiduciary with
respect to any such plan when acting in that capacity.
C. A Person shall be a "beneficial owner" of any Voting Shares:
(i) which such Person or any of its Affiliates or Associates (as
hereinafter defined) beneficially owns, directly or indirectly; or
(ii) which such Person or any of its Affiliates or Associates has
(a) the right to acquire (whether such right is exercisable immediately
or only after the passage of time) pursuant to any agreement,
arrangement or understanding or upon the exercise of conversion rights,
exchange rights, warrants or options, or otherwise, or (b) the right to
vote pursuant to any agreement, arrangement or understanding; or
(iii) which is beneficially owned, directly or indirectly, by any
other Person with which such Person or any of its Affiliates or
Associates has any agreement, arrangement or understanding for the
purpose of acquiring, holding, voting or disposing of any shares of
Voting Shares.
D. For the purpose of determining whether a Person is a Related Person
pursuant to paragraph B of this Section, the number of shares of Voting
Shares deemed to be outstanding shall include shares deemed owned through
application of paragraph C of this Section, but shall not include any other
shares of Voting Shares which may be issuable pursuant to any agreement,
arrangement or understanding, or upon exercise of conversion rights,
warrants or options, or otherwise.
E. "Affiliate" or "Associate" shall have the respective meanings
ascribed to such terms in Rule 12b-2 of the General Rules and Regulations
under the Securities Exchange Act of 1934, as in effect on January 1, 1986.
F. "Subsidiary" means any corporation of which a majority of any class
of Equity Security is owned, directly or indirectly, by the Corporation;
provided, however, that for the purposes of the definition of Related
Person set forth in paragraph B of this Section, the term "Subsidiary"
shall mean only a corporation of which a majority of each class of Equity
Security is owned, directly or indirectly, by the Corporation.
G. "Continuing Director" means any member of the Board of Directors
who is unaffiliated with the "Related Person" and was a member of the Board
of Directors prior to the time that the Related Person became a Related
Person, and any successor of a Continuing Director who is unaffiliated with
the Related Person and is recommended to succeed a Continuing Director by
two-thirds of the Continuing Directors then on the Board of Directors.
H. "Fair Market Value" means: (i) in the case of stock, the highest
closing sales price during the 30-day period immediately preceding the date
in question of a share of such stock on the Composite Tape for New York
Stock Exchange -- Listed Stocks, or, if such stock is not quoted on the
composite Tape, on the New York Stock Exchange, or, if such stock is not
listed on the Exchange, on the principal United States securities exchange
registered under the Securities Exchange Act of 1934 on which such stock is
listed, or, if such stock is not listed on any such exchange, the highest
closing bid quotation with respect to a share of such stock during the
30-day period preceding the date in question on the National Association of
Securities
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Dealers, Inc. Automated Quotations Systems or any system then in use, or if
no such quotations are available, the fair market value on the date in
question of a share of such stock as determined by a two-thirds vote of the
Continuing Directors; and (ii) in the case of property other than cash or
stock, the fair market value of such property on the date in question as
determined by a two-thirds vote of the Continuing Directors.
I. In the event of any Business Combination in which the Corporation
survives, the phrase "consideration other than cash to be received" as used
in paragraph A of this Section shall include the shares of any class of
Equity Security retained by the holders of such shares.
J. "Equity Security" shall have the meaning ascribed to such term in
Section 3(a)(11) of the Securities Exchange Act of 1934, as in effect on
January 1, 1986.
K. "Voting Shares" means shares of any Equity Security of a
corporation which are entitled to vote in the election of Directors of such
corporation.
L. The phrase "series of related transactions" shall be deemed to
include not only a series of transactions with the same Related Person but
also a series of separate transactions with a Related Person or any
Affiliate or Associate of such Related Person.
(5) The Continuing Directors shall, by two-thirds vote, have the power and
duty to determine for the purposes of this Article EIGHTH on the basis of
information known to them after reasonable inquiry, (A) whether a Person is a
Related Person, (B) the number of shares of Voting Shares beneficially owned by
any Person, (C) whether a Person is an Affiliate or Associate of another, (D)
whether the assets which are the subject of any Business Combination have, or
the consideration to be received for the issuance or transfer of securities by
the Corporation or any Subsidiary in any Business Combination has, an aggregate
Fair Market Value equal to 10% or more of the consolidated net worth of the
corporation. The Continuing Directors shall, by two-thirds vote, have the
further power to interpret all other terms and provisions of this Article
EIGHTH.
(6) Nothing contained in this Article EIGHTH shall be construed to relieve
any Related Person from any fiduciary obligation imposed by law.
NINTH: Notwithstanding any statutory provision now or hereafter in force
requiring for any purpose the vote, consent, waiver or release of the holders of
shares entitling them to exercise two-thirds, or any other proportion, of the
voting power of the Corporation or of any class or classes of shares thereof,
such action, unless otherwise expressly required by statute or by these
Articles, may be taken by the vote, consent, waiver or release of the holders of
shares entitling them to exercise a majority of the voting power of the
Corporation or of such class or classes. Each of Articles SIXTH, SEVENTH and
EIGHTH and this Article NINTH, of these Articles of Incorporation may be amended
at any regular or special meeting of the shareholders only by the affirmative
vote of the holders of at least 75% of the voting power of the outstanding
shares of this Corporation.
TENTH: Any and every statute of the State of Ohio hereafter enacted,
whereby the rights, powers or privileges of corporations or of the shareholders
of corporations organized under the laws of the State of Ohio are increased or
diminished or in any way affected, or whereby effect is given to the action
taken by any number, less than all, of the shareholders of any such corporation,
shall apply to the Corporation and shall be binding not only upon the
Corporation, but upon every shareholder of the Corporation to the same extent as
if such statute had been in force at the date of filing these Articles of
Incorporation of the Corporation in the office of the Secretary of State of
Ohio. The right to alter, amend, change or repeal any clause or provision of
these Articles of Incorporation, in the manner now or hereafter prescribed by
law, is hereby reserved to the Corporation; and all rights conferred on
officers, Directors and shareholders herein are granted subject to such
reservation.
Executed this 15th day of August, 1986.
/s/ John L. Pogue, Incorporator
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10.15 FORM OF NON-QUALIFIED STOCK OPTION AGREEMENT.
NON-QUALIFIED STOCK OPTION AGREEMENT
FOR , AWARD
pursuant to
SECOND BANCORP INCORPORATED
1998 NON-QUALIFIED STOCK OPTION PLAN
THIS NON-QUALIFIED STOCK OPTION AGREEMENT (the "Agreement") made and
entered into as of the day of , ,
between Second Bancorp Incorporated (the "Company") and (the
"Optionee").
WHEREAS, the Company having determined that its interests will be advanced
by (a) providing incentive to officers, key employees, and non-employee
directors of the Company and The Second National Bank of Warren (its
"Subsidiary") to stimulate their efforts toward the continued success of the
Company and its Subsidiary and to operate and manage the business in a manner
which will provide for the long-term growth and profitability of the Company and
its Subsidiary, (b) encouraging stock ownership by officers, key employees and
non-employee directors; and (c) providing a means of attracting, retaining and
rewarding key employees and non-employee directors; and
WHEREAS, the Company and its shareholders have approved the Second Bancorp
Incorporated 1998 Non-Qualified Stock Option Plan (the "Plan") pursuant to which
the Company (a) grants stock options to the non-employee directors of the
Company and Subsidiary, and (b) may grant stock options to its officers and key
employees from time to time as determined in the sole discretion of the
Compensation and Organization Committee of the Board of Directors of the Company
(the "Committee");
NOW, THEREFORE, in consideration of the premises and of the mutual
covenants and agreements hereinafter set forth, the Company and Optionee hereby
mutually covenant and agree as follows:
GRANT OF OPTIONS. Effective , (the "Award Date"),
the Company hereby grants to the Optionee, as a matter of separate agreement and
not in lieu of salary, fee or other compensation for services, the right and
option to purchase full shares of authorized but unissued common
stock of the Company on the terms and conditions herein set forth (the "Award").
Notwithstanding the foregoing, the Optionee understands and agrees that if, in
the sole determination of the Committee, the option Award prevents or in any way
adversely affects the Company's qualification for "pooling" treatment of any
acquisition, this Award may be withdrawn or adjusted by the Company in any
manner deemed necessary by the Committee to preserve that accounting treatment.
PRICE. The purchase price of said shares of common stock subject to the Award
shall be Dollars ($ ) per share, the fair market value
of the common stock on the date of the grant pursuant to the Plan.
3. EXERCISE OF OPTIONS. Except as otherwise provided in this
Agreement, the options granted pursuant to this Award shall become 100%
vested, and therefore fully exercisable, on the first anniversary of the
Award Date and shall remain in effect until the EARLIEST of (a) the date on
which all options granted hereunder have been exercised, (b) the date on
which the options granted hereunder have terminated pursuant to the
provisions of Sections 1 or 6 of this Agreement, or (c) the tenth
anniversary of the Award Date ("Option Term"). No less than one thousand
(1,000) shares may be purchased upon any one exercise of options granted
pursuant to this Award unless the number of shares purchased at such time
is the total number of shares in respect of which the options hereby
granted are then exercisable. In no event shall any option granted hereby
be exercisable for a fractional share.
4. METHOD OF EXERCISING OPTIONS AND PAYMENT OF OPTION PRICE. Subject
to the terms and conditions of this Agreement, the options granted pursuant
to this Award may be exercised by delivering to the Company at the office
of its Treasurer, a written notice of the election to exercise all or a
portion of the options granted pursuant to this Award. Each written notice
shall be given in the form of EXHIBIT A attached
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hereto and signed by the Optionee or such other person entitled to exercise
the options in question. Any such written notice shall, as an essential
part thereof, be accompanied by payment in form satisfactory to the Company
of the full exercise price of the options then to be exercised. Upon the
proper exercise of the options granted pursuant to this Award, the Company
shall issue in the name of the person exercising the options or such other
name as that person may indicate, and shall deliver to such person, a
certificate or certificates for the shares purchased. The Optionee agrees
that as holder of this Award, the Optionee shall have no rights as a
shareholder or otherwise in respect of any of the shares as to which the
options granted pursuant to this Award shall not have been effectively
exercised as herein provided.
5. ASSIGNABILITY. The options granted pursuant to the terms of this
Award shall not be transferable or assignable except (a) by the laws of
descent and distribution, (b) to a spouse or lineal descendent (a "Family
Member"), (c) to a trust for the exclusive benefit of a Family Member, or
(d) to a partnership, limited liability company or other entity in which
all the beneficial owners are Family Members. The Optionee shall promptly
notify the Company of any transfer or assignment pursuant to (b), (c), or
(d) above and, absent any such notification, the Company shall have no
obligation to honor or recognize the same.
6. TERMINATION. The options granted hereby shall terminate and be of
no force or effect upon the expiration of the Option Term unless terminated
prior to such time as provided below. The Optionee's options shall
terminate or be exercisable as follows:
(a) Termination of Employment or Directorship. If Termination of
Employment or Termination of Directorship occurs, the options granted
hereby shall terminate as of the date of Termination of Employment or
Termination of Directorship, as applicable.
(b) Retirement. Notwithstanding (a) immediately above, in the event
of retirement from service to the Company or Subsidiary at an age not
less than 55, the Optionee may exercise the options granted hereby
within the shorter of three (3) years from the date of the Optionee's
retirement or the expiration of the Option Term.
(c) Disability. Notwithstanding (a) immediately above, upon the
Optionee's Disability the options granted hereby are exercisable by the
Optionee or the Optionee's legal representative, if any, for the shorter
of three (3) years from the date of the Optionee's Disability or the
expiration of the Option Term.
(d) Death. Notwithstanding (a) immediately above, if (i) Optionee
dies while serving as a director or employee of the Company or
Subsidiary, the Optionee's estate, personal representative, or
beneficiary (as applicable) shall have the right to exercise the options
granted hereby for the shorter of three (3) years from the date of the
Optionee's death or the expiration of the Option Term, and (ii) if
Optionee dies within the period of time after retirement from service to
the Company or Subsidiary during which the Optionee would have been
entitled to exercise options granted hereby, the Optionee's estate,
personal representative, or beneficiary (as applicable) shall have the
right to exercise the options granted hereby for the shorter of three
(3) years from the date of the Optionee's retirement or the expiration
of the Option Term.
7. CHANGE IN CONTROL. Notwithstanding any other provision of this
Agreement, in the event a Change in Control, or execution of agreements
which will result in a Change in Control, occurs prior to the first
anniversary date of the Award evidenced hereby, the options granted
hereunder shall immediately be and become fully exercisable by the Optionee
(or such other person provided for in this Agreement) and shall thereafter
remain fully exercisable until the expiration of the Option Term or
termination of the options hereunder.
8. WITHHOLDING TAX. Whenever the Company proposes or is required to
issue or transfer shares of common stock of the Company under the Plan or
this Agreement, the Company shall have the right to require the Optionee to
remit to the Company cash (or cash equivalent acceptable to the Company) in
an amount sufficient to satisfy and federal, state, local, or employment
taxes that it deems are required by statute to be withheld.
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9. PREEMPTION BY APPLICABLE LAWS OR REGULATIONS. The options granted
pursuant to this Award shall not be exercisable if such exercise would
violate:
(a) Any applicable state securities law;
(b) Any applicable registration or other requirement under the
Securities Act of 1933, as amended, the Securities Exchange Act of 1934,
as amended, or the listing requirements of and exchange; or
(c) Any applicable legal requirement of any other governmental
authority.
Should a violation exist, the Company and/or the Optionee agree to make
reasonable efforts to comply with the foregoing laws and requirements so
as to permit the exercise of the options granted pursuant to this Award.
10. RESOLUTION OF DISPUTES. Any dispute or disagreement which shall
arise under, or as a result of, or pursuant to, this Agreement shall be
resolved by the Committee in its absolute and uncontrolled discretion, and
any such resolution or any other determination by the Committee under or
pursuant to this Agreement shall be final, binding, and conclusive on all
persons affected thereby.
11. CONSTRUCTION. This Agreement has been entered into in accordance
with the terms of the Plan, and wherever a conflict may arise between the
terms of this Agreement and the terms of the Plan, the terms of the Plan
shall control. Any capitalized terms used but not otherwise defined in this
Agreement shall have the meaning assigned to it in the Plan.
12. OPTIONEE. Whenever the term Optionee is used in any provision of
this Agreement under circumstances where the provision should logically be
construed to apply to the estate, personal representative, Family Member,
or beneficiary to whom the options granted pursuant to this Award may be
transferred, the word Optionee shall be deemed to include such person or
entity.
13. GOVERNING LAW. This Agreement shall be governed by the laws of the
state of Ohio, except to the extent preempted by the laws of the United
States.
IN WITNESS WHEREOF, The Company and the Optionee have executed this
Agreement in duplicate as of the date first written above.
SECOND BANCORP INCORPORATED
By:
--------------------------- --------------------------
Optionee
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EXHIBIT A
EXERCISE NOTICE FORM
FOR
NON-QUALIFIED STOCK OPTIONS
TO: TREASURER,
SECOND BANCORP INCORPORATED (THE "COMPANY")
DATE:
1. The undersigned, ("Optionee"), hereby irrevocably
elects to exercise options granted to him/her pursuant to the award
of non-qualified stock options dated to the extent of
shares of the Company's common stock.
2. In payment of the option price for those shares, the undersigned herewith
makes (or arranges to the Company's satisfaction) payment in the amount of
$ .
3. The effective date of this exercise is .
--------------------------------------
Signature of Optionee
--------------------------------------
Print Name
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EXHIBIT 21 -- SUBSIDIARIES OF REGISTRANT
The Corporation has one subsidiary, The Second National Bank of Warren, which is
incorporated under the laws of the United States and is wholly owned by the
Corporation.
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<PAGE> 1
EXHIBIT 23.1 -- CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-3 No. 333-46143) pertaining to the Dividend Reinvestment and Stock Purchase
Plan of Second Bancorp, Inc. and in the related Prospectus and in the
Registration Statement (Form S-8 No. 33-42347) pertaining to the 1991 Incentive
Stock Option Plan of Second Bancorp, Inc. of our report dated January 26, 1999
with respect to the consolidated financial statements of Second Bancorp, Inc.
included in the Annual Report (Form 10-K) for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Cleveland, Ohio
March 24, 1999
68
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