<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[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
-----------------
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to .
------ ------
Commission file Number 000-24157
Security Financial Corp.
- ------------------------------------------------------------------------------
(Name of Small Business Issuer in its charter)
Delaware 34-1579662
- --------------------------------------- -------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1 South Main St., Niles, OH 44446-0228
- --------------------------------------- -------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, (330) 544-7400
--------------------------------------------------
Securities to be registered under Section 12(b) of the Act: None
----
Securities to be registered under Section 12(g) of the Act:
Common Stock, par value - no par value
--------------------------------------
(Title of Class)
Check whether the issuer: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the Registrant was required to file such Reports),
and (2) has been subject to such filing requirements for the past 90 days.
YES X NO .
----- -----
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year. $13,542,000
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the Average bid and asked price of the Registrant's
Common Stock on March 15, 1999 was $22.7 million.
As of March 15, 1999, there were issued and outstanding 347,028 shares
of the Registrant's Common Stock.
Transition Small Business Disclosure Format (check one): YES NO X .
---- ----
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year ended
December 31, 1998. (Part II)
2. Portions of the Proxy Statement for the Annual Meeting of Stockholders
for the Fiscal Year ended December 31, 1998. (Part III)
2
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ITEM 1. DESCRIPTION OF BUSINESS
PART I
The purpose of the Security Financial Corp. (the "Company") is to engage
in any lawful act or activity for which corporations may be organized under
the General Company Law of Delaware.
Forward Looking Statements
- --------------------------
Security Financial Corporation (the "Company") may from time to time
make written or oral "forward-looking statements," including statements
contained in the Company's filings with the Securities and Exchange Commission
(including this Annual Report on Form 10-KSB and the exhibits thereto), in it
reports to stockholders and in other communications by the Company, which are
made in good faith by the Company pursuant to the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such
as statements of the Company's plans, objectives, expectations, estimates and
intentions, that are subject to change based on various important factors
(some of which are beyond the Company's control). The following factors,
among others, could cause the Company's financial performance to differ
materially from the plans, objectives, expectations, estimates and intentions
expressed in such forward-looking statements: the strength of the United
States economy in general and the strength of the local economies in which the
Company conducts operations; the effects of, and changes in, trade, monetary
and fiscal policies and laws, including interest rate policies of the Board of
Governors of the Federal Reserve System, inflation, interest rate, market and
monetary fluctuations; the timely development of and acceptance of new
products and services of the Company and the perceived overall value of these
products and services by users; including the features, pricing and quality
compared to competitors' products and services; the willingness of the users
to substitute competitors' products and services for the Company's products
and services; the success of the Company in gaining regulatory approval of its
products and services, when required; the impact of changes in financial
services' laws and regulations (including laws concerning taxes, banking,
securities, and insurance); technological changes, acquisitions; changes in
consumer spending and savings habits; and the success of the Company at
managing the risks involved in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or
on behalf of the Company.
General
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The Company was incorporated under the laws of the State of Delaware on
November 23, 1987, at the direction of management of the Bank, for the purpose
of becoming a bank holding company by acquiring all of the outstanding shares
of Security Dollar Bank (the "Bank"). In March 1988, the Company became the
sole shareholder of the Bank. The Bank carries on business under the name
"Security Dollar Bank." The principal office of the Company is located at 1
South Main Street, Niles, Ohio 4446-0228.
The Company, through its affiliate, conducts the business of a
commercial banking organization. At February 28, 1999, the Company and its
subsidiary had consolidated total assets of approximately $166.5 million,
consolidated total deposits of approximately $142.5 million and consolidated
total equity of approximately $14.6 million.
The Company, through its banking affiliate, offers a broad range of
banking services to the commercial, industrial and consumer market segments
which it serves. Services include commercial, real estate and personal loans;
checking, savings and time deposits and other customer services such as safe
deposit facilities. The Company does not have any foreign operations, assets
or investments.
3
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The Bank is a state banking corporation. The Bank is regulated by the
Ohio Division of Financial Institutions ("ODFI") and its deposits are insured
by the Federal Deposit Insurance Corporation to the extent permitted by law
and, as a subsidiary of the Company, is regulated by the Federal Reserve
Board.
The Bank is headquartered in Niles, Ohio, which is located in the
northeast portion of Ohio, in the County of Trumbull. Trumbull County has a
population of approximately 227,000. The population in Trumbull County
decreased during the period 1990-1995 by .47%. This compares to a growth in
population during the same period for the State of Ohio of 1.7%. As of
December 31, 1997, median household income for Trumbull County was 93% of the
State of Ohio median household income. Historically the steel industry
accounted for a large segment of the economic activity in Trumbull County.
Over the past 10 years less dependence on the steel industry has occurred with
a resulting increase in service related businesses. The areas largest single
employer is General Motors which operates an assembly facility within Trumbull
County. The Bank provides customary retail and commercial banking services to
its customers, including checking and savings accounts, time deposits, NOW
accounts, safe deposit facilities, real estate mortgage loans and installment
loans. The Bank also makes secured and unsecured commercial loans.
The largest category of loans comprising the Bank's Loan Portfolio is
Residential Real Estate Loans. These loans are primarily single family
residential real estate loans secured by a first mortgage on the dwelling.
The risks associated with these loans are primarily the risk of default in
repayment and inadequate collateral. Consumer and credit card loans comprise
the next largest area of the Bank's loan portfolio. These loans include
consumer installment including automobile loans as well as personal loans and
credit card loans. The risks inherent in these loans include the risk of
default in principal, repayment and in the case of secured loans the risk of
inadequate collateral. The third largest loan segment of the Bank's Loan
Portfolio is the Commercial category. The loans comprising this category
represent loans to business interests, located primarily within the Bank's
defined market areas, with no significant industry concentration. Commercial
Loans include both secured and unsecured loans. The risks associated with
these loans are principally the risk in default of the payment of principal
resulting from economic problems of the commercial customer, economic downturn
effecting the market in general and in the case of secured loans inadequate
collateral.
Employees
- ---------
As of December 31, 1998, the Bank had 82 full-time and 18 part-time
employees. The Bank provides a number of benefits for its full-time
employees, including health and life insurance, pension, workers'
compensation, social security, paid vacations, and numerous bank services.
Competition
- -----------
The commercial banking business in the market areas served by the Bank
is very competitive. The Company and the Bank are in competition with
commercial banks located in their own service areas. Some competitors of the
Company and the Bank are substantially larger than the Bank. In addition to
local bank competition, the Bank competes with larger commercial banks located
in metropolitan areas, savings banks, savings and loan associations, credit
unions, finance companies and other financial institutions for loans and
deposits.
Certain Regulatory Considerations
- ---------------------------------
The following is a summary of certain statutes and regulations affecting
the Company and its subsidiaries. This summary is qualified in its entirety
by such statutes and regulations.
The Company
- -----------
The Company is a registered bank holding company under the Bank Holding
Company Act of 1956, as amended, ("BHC Act") and as such is subject to
regulation by the Federal Reserve Board. A bank holding company is required
to file with the Federal Reserve Board quarterly reports and other information
regarding its business operations and those of its subsidiaries. A bank
holding company and its subsidiary banks are also subject to examination by
the Federal Reserve Board.
4
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The BHC Act requires every bank holding company to obtain the prior
approval of the Federal Reserve Board before acquiring substantially all the
assets of any bank or bank holding company or ownership or control of any
voting shares of any bank or bank holding company, if, after such acquisition,
it would own or control, directly or indirectly, more than five percent (5%)
of the voting shares of such bank or bank holding company.
In approving acquisitions by bank holding companies of companies engaged
in banking-related activities, the Federal Reserve Board considers whether the
performance of any such activity by a subsidiary of the holding company
reasonably can be expected to produce benefits to the public, such as greater
convenience, increased competition, or gains in efficiency, which outweigh
possible adverse effects, such as over concentration of resources, decrease of
competition, conflicts of interest, or unsound banking practices.
Bank holding companies are restricted in, and subject to, limitations
regarding transactions with subsidiaries and other affiliates.
In addition, bank holding companies and their subsidiaries are
prohibited from engaging in certain "tie in" arrangements in connection with
any extensions of credit, leases, sales of property, or furnishing of
services.
The Company's Subsidiary
- ------------------------
The Company operates a single bank, namely, Security Dollar Bank. As an
Ohio state chartered commercial bank the Bank is supervised and regulated by
the ODFI, and subject to laws and regulations applicable to Ohio banks.
Capital
- -------
The Federal Reserve Board, ODFI, and FDIC require banks and holding
companies to maintain minimum capital ratios.
The Federal Reserve Board adopted final "risk-adjusted" capital
guidelines for bank holding companies. The guidelines became fully
implemented as of December 31, 1992. The ODFI and FDIC have adopted
substantially similar risk-based capital guidelines. These ratios involve a
mathematical process of assigning various risk weights to different classes of
assets, then evaluating the sum of the risk-weighted balance sheet structure
against the Company's capital base. The rules set the minimum guidelines for
the ratio of capital to risk-weighted assets (including certain off-balance
sheet activities, such as standby letters of credit) at 8%. At least half of
the total capital is to be composed of common equity, retained earnings, and a
limited amount of perpetual preferred stock less certain goodwill items ("Tier
1 Capital"). The remainder may consist of a limited amount of subordinated
debt, other preferred stock, or a limited amount of loan loss reserves.
In addition, the federal banking regulatory agencies have adopted
leverage capital guidelines for banks and bank holding companies. Under these
guidelines, banks and bank holding companies must maintain a minimum ratio of
three percent (3%) Tier 1 Capital (as defined for purposes of the year-end
1992 risk-based capital guidelines) to total assets. The Federal Reserve
Board has indicated, however, that banking organizations that are experiencing
or anticipating significant growth, are expected to maintain capital ratios
well in excess of the minimum levels.
Regulatory authorities may increase such minimum requirements for all
banks and bank holding companies or for specified banks or bank holding
companies. Increases in the minimum required ratios could adversely affect
the Company and the Banks, including their ability to pay dividends.
Additional Regulation
- ---------------------
The Bank is also subject to federal regulation as to such matters as
required reserves, limitation as to the nature and amount of its loans and
investments, regulatory approval of any merger or consolidation, issuance or
retirement of their own securities, limitations upon the payment of dividends
and other aspects of banking operations. In addition, the activities and
operations of the Bank are subject to a number of additional detailed, complex
and sometimes overlapping laws and regulations. These include state usury and
consumer credit laws, state laws relating to fiduciaries, the Federal
Truth-in-Lending Act and
5
<PAGE>
Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the
Fair Credit Reporting Act, the Truth in Savings Act, the Community
Reinvestment Act, anti-redlining legislation and antitrust laws.
Dividend Regulation
- -------------------
The ability of the Company to obtain funds for the payment of dividends
and for other cash requirements is largely dependent on the amount of
dividends which may be declared by the Bank. Generally, the Bank may not
declare a dividend, without the approval of the ODFI, if the total of
dividends declared in a calendar year exceeds the total of its net profits for
that year combined with its retained profits of the preceding two years.
Government Policies and Legislation
- -----------------------------------
The policies of regulatory authorities, including the ODFI, Federal
Reserve Board, FDIC and the Depository Institutions Deregulation Committee,
have had a significant effect on the operating results of commercial banks in
the past and are expected to do so in the future. An important function of
the Federal Reserve System is to regulate aggregate national credit and money
supply through such means as open market dealings in securities, establishment
of the discount rate on member bank borrowings, and changes in reserve
requirements against member bank deposits. Policies of these agencies may be
influenced by many factors, including inflation, unemployment, short-term and
long-term changes in the international trade balance and fiscal policies of
the United States government.
The United States Congress has periodically considered and adopted
legislation which has resulted in further deregulation of both banks and other
financial institutions, including mutual funds, securities brokerage firms and
investment banking firms. No assurance can be given as to whether any
additional legislation will be adopted or as to the effect such legislation
would have on the business of the Company or the Bank.
In addition to the relaxation and elimination of certain geographic
restrictions on banks and bank holding companies, a number of regulatory and
legislative initiatives have the potential for eliminating many of the product
line barriers presently separating the services offered by commercial banks
from those offered by nonbanking institutions. For example, Congress recently
has considered legislation which would expand the scope of permissible
business activities for bank holding companies (and in some cases banks) to
include securities underwriting, insurance services and various real estate
related activities.
Deposit Insurance
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The Federal Deposit Insurance Company Improvement Act of 1991 ("FDICIA")
was enacted in 1991. Among other things, FDICIA, requires federal bank
regulatory authorities to take "prompt corrective action" with respect to
banks that do not meet minimum capital requirements. For these purposes,
FDICIA establishes five capital tiers: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, and critically
undercapitalized.
As an FDIC-insured institution, the Bank is required to pay deposit
insurance premium assessments to the FDIC. The amount each institution pays
for FDIC deposit insurance coverage is determined in accordance with a
risk-based assessment system under which all insured depository institutions
are placed into one of nine categories and assessed insurance premiums based
upon their level of capital and supervisory evaluation. Institutions
classified as well-capitalized (as defined by the FDIC) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered substantial supervisory
concerns pay the highest premium. Because the Bank is "well-capitalized," it
currently pays the minimum deposit insurance premiums.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or written
agreement with, the FDIC. The FDIC may also suspend deposit insurance
temporarily during the hearing process for a permanent termination of
insurance if the institution has no tangible capital. Management of the
Company is not aware of any activity or condition that could result in
termination of the deposit insurance of the Bank.
6
<PAGE>
Proposed Legislation
- --------------------
In addition to the above, there have been proposed a number of
legislative and regulatory proposals designed to strengthen the federal
deposit insurance system and to improve the overall financial stability of the
U.S. banking system. It is impossible to predict whether or in what form
these proposals may be adopted in the future, and if adopted, what their
effect would be on the Company.
Selected Financial Information
- ------------------------------
The following table sets forth certain information concerning the consolidated
financial position of the Company at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands, except shares and per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Income:
Interest income $ 12,657 $ 12,848 $ 11,269 $ 8,995 $ 7,380
Interest expense 6,492 6,328 5,457 4,243 2,949
Net interest income 6,165 6,520 5,812 4,752 4,431
Provision for loan losses 2,267 1,250 668 198 290
Net interest income after
provision for loan losses 3,898 5,270 5,144 4,554 4,141
Investment securities gains, net 51 25 26 22 21
Other noninterest income 834 916 801 728 707
Other noninterest expense 4,730 4,284 4,186 3,832 3,421
Federal income tax expense (benefit) (100) 609 543 422 427
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Net Income $ 153 $ 1,318 $ 1,241 $ 1,049 $ 1,020
=====================================================================
Per share of common stock (1):
Net income $ 0.44 $ 4.01 $ 4.35 $ 3.76 $ 3.82
Dividends 1.24 1.12 0.97 0.87 0.66
Book value 42.49 42.64 37.46 34.42 30.60
Average common shares outstanding 344,669 320,732 277,408 271,219 259,597
<PAGE>
Year-end balances:
Loans receivable, net $ 108,952 $ 110,751 $ 113,310 $ 81,988 $ 66,370
Investment securities available
for sale 44,360 41,639 26,691 18,737 17,782
Total assets 172,074 167,258 152,899 127,064 107,880
Cash and cash equivalents 10,733 8,906 6,868 6,189 7,298
Deposits 148,917 145,352 129,670 109,571 94,188
Borrowings 7,649 6,524 11,754 7,246 4,974
Stockholder's equity 14,744 14,633 10,779 9,789 8,388
</TABLE>
7
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KEY OPERATING RATIOS:
Return on average assets (net income
divided by average total assets) 0.09 0.81 0.86 0.90 1.00
Return on average equity (net income
divided by average equity) 1.04 9.83 12.14 12.51 13.73
Dividend payout ratio (dividends
declared per share divided by net
income per share) 281.81 27.98 22.35 23.26 17.30
Equity to assets ratio (average equity
divided by average total assets) 8.72 8.26 7.12 7.19 7.28
Allowance for loan losses to
nonperforming loans 105.32 64.51 85.75 236.45 167.18
- ---------------------------------
(1) All share and per share data has been restated for the effect of common
stock dividends and splits.
Investment Securities
- ---------------------
The investment portfolio, increased by $2.7 million or 6.5% in 1998. Most of
the increase occurred in mortgage-backed securities and obligations of states
and political subdivisions, which grew by $5.6 million and $3.1 million,
respectively. The increase is primarily attributable to the reinvestment of
funds from the maturity of U.S. Treasury and Government agency securities with
higher yielding mortgage-backed securities, as well as obligations of states
and political subdivisions. The deposits and other liabilities that are not
used to fund loans are placed in investments which possess less risk and,
therefore, lower yield. The impact on net interest income is discussed later
in the Net Interest Income section.
In general investment in securities is limited to those funds the bank feels
it has in excess of funds used to satisfy loan demand and operating
considerations.
The following table shows the amortized cost and estimated market value of
investment securities by type of obligation at the dates indicated.
The amortized cost, unrealized gains and losses and estimated fair values are
as follows at December 31:
1998
------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------------------
U.S. Treasury and Government
agency securities $ 6,824,464 $ 15,258 $ (3,187) $ 6,836,535
Obligations of states and
political subdivisions 9,182,033 105,136 (59,101) 9,228,068
Mortgage-backed securities 26,499,393 339,260 (164,157) 26,674,496
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Total debt securities 42,505,890 459,654 (226,445) 42,739,099
Equity securities 1,468,638 158,793 (6,716) 1,620,715
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Total investment
securities $43,974,528 $ 618,447 $(233,161) $44,359,814
================================================
8
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1997
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Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
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U.S. Treasury and Government
agency securities $13,456,631 $ 30,215 $ (16,167) $13,470,679
Obligations of states and
political subdivisions 6,087,660 91,342 (12,734) 6,166,268
Mortgage-backed securities 20,770,857 132,780 (147,395) 20,756,242
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Total debt securities 40,315,148 254,337 (176,296) 40,393,189
Equity securities 1,130,882 114,431 - 1,245,313
-----------------------------------------------
Total investment
securities $41,446,030 $ 368,768 $(176,296) $41,638,502
===============================================
The Company's investment securities portfolio at December 31, 1998 did
not contain securities of any issues with an aggregate book value in excess of
10% of the Company's equity, excluding those issued by the United States
Government or its agencies.
9
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The following table sets forth certain information regarding the carrying
values, weighted average yields and maturities of the Bank's investment
securities portfolio at December 31.
<TABLE>
<CAPTION>
1998
----------------------------------------------------------------------------------------------------------------
One One Five to Ten More than Ten
year or less to Five Years Years Years Total Investment Securities
------------------ ------------------ ------------------ ------------------ --------------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
Investment
- ----------
securities:
-----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
agency securities $ 526 5.55% $ 6,011 6.28% $ 300 7.25% $ - -% $ 6,837 6.27% $ 6,837
Obligations of
state and political
subdivisions 50 5.61 270 8.41 644 7.89 8,264 8.27 9,228 8.24 9,228
Interest-bearing
deposits in other
financial
institutions 896 5.60 398 5.80 - - - - 1,294 5.66 1,294
Mortgage-backed
securities 52 10.00 1,240 9.48 3,394 9.64 21,988 7.97 26,674 8.25 26,674
Equity securities 589 3.59 - - - - - - 589 3.59 589
FHLB Stock (1) 880 7.00 - - - - - - 880 7.00 880
------------------ ----------------- ----------------- ------------------ -------------------- ---------
Total $ 2,993 5.68% $ 7,919 6.83% $ 4,338 9.21% $ 30,252 8.05% $ 45,502 7.79% $ 45,502
================== ================= ================= ================== ==================== =========
</TABLE>
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(1) Recorded at cost.
10
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Loans
- -----
Historically, loans have been originated by the Company to customers in East
Central Ohio. Loans have been originated primarily through direct loans to
our existing customer base, with new customers generated by referrals from
real estate brokers, building contractors, attorneys, accountants and existing
customers. The Company also generates indirect loans through new and used car
dealers in the primary lending area.
All lending is governed by a lending policy which is developed and maintained
by management and approved by the Board of Directors. The Company's lending
policy regarding real estate loans is that generally the maximum mortgage
granted on owner-occupied residential property is 80% of the appraised value
or purchase price (whichever is lower) when secured by the first mortgage on
the property. Home equity lines of credit or second mortgage loans are
generally originated subject to maximum mortgage liens against the property of
80% of the current appraised value. The maximum term for mortgage loans is 30
years for one- to four-family residential property and 15 years for commercial
and vacation property.
As shown in the following table, total loans declined by $1.7 million in 1998,
or 1.49%, compared to a $2.5 million or 1.76% decrease during 1997. The
product mix in the loan portfolio shows commercial loans comprising 9.26%,
real estate mortgage loans (residential and commercial) 65.68% and installment
loans to individuals 25.06% at December 31, 1998 compared with 11.92%, 56.26%
and 31.82%, respectively December 31, 1997.
Real estate mortgage loans increased to $72.7 million at December 31, 1998, an
increase of $9.5 million over 1997. This growth centered principally in the
commercial real estate market which increased $8.2 million due to the economic
health within the Company's market area. The real estate portfolio consists
of $47.5 million of 1-4 family residential properties and $24.8 million and
$454,000 in commercial real estate and construction properties, respectively,
all made within the Company's primary market area. The Company originated
both fixed rate and adjustable rate mortgages during 1998. Fixed rate loans
that are maintained in the portfolio are limited to fifteen-year terms while
adjustable rate products are offered with maturities up to thirty years.
Commercial loans at December 31, 1998 decreased $3.1 million to $10.3 million
compared to $13.4 million at December 31, 1997. This portfolio, which is
comprised primarily of variable rate loans, is granted to customers within the
immediate trade area of the Company. The mix is diverse, covering a wide
range of borrowers and business types. The Company monitors and controls
concentrations within a particular industry or segment of the economy. These
loans are made for purposes such as equipment purchases, capital and leasehold
improvements, the purchase of inventory, general working capital purposes and
small business lines of credit.
Installment loans to individuals decreased from $35.8 million on December 31,
1997 to $27.8 million on December 31, 1998 which represents a 22.43% decrease.
Although management continues to target the automobile dealer network to
originate indirect installment loans, the Company has experienced significant
loan losses in relation to this portfolio. In an effort to remedy this
situation, management has been stringently enforcing existing underwriting
guidelines which has led to a reduction in the number of indirect installment
loans originated.
11
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At December 31,
----------------------------------------------------
1998 1997
----------------------------------------------------
Amount Percent Amount Percent
---------- ---------- ---------- ----------
Type of Loan (Dollars in Thousands)
- ------------
Real Estate Loans:
Construction $ 454 0.41% $ 623 0.55%
One to four family 47,501 42.89 46,064 40.97
Commercial 24,791 22.38 16,565 14.74
Commercial 10,255 9.26 13,398 11.92
Consumer loans 27,754 25.06 35,779 31.82
---------- ---------- ---------- ---------
Total loans 110,755 100.00% 112,429 100.00%
========== =========
Less:
Allowance for possible
loan losses (1,803) (1,678)
---------- ----------
Total loans, net $ 108,952 $ 110,751
========== ==========
Allowance for Loan Losses
- -------------------------
The provisions for possible loan losses charged to operating expense is based
on management's judgment after taking into consideration all factors connected
with the collectability of the existing loan portfolio. Management evaluates
the loan portfolio in light of economic conditions, changes in the nature and
volume of the loan portfolio, industry standards and other relevant factors.
Specific factors are considered by management in determining the amounts
charged to operating expenses include previous credit loss experience, the
status of past due interest and principal payments, the quality of financial
information supplied by loan customers and the general condition of the
industries in the community to which loans have been made.
Provisions charged to operations increased from $1.26 million in 1997 to $2.27
million in 1998. The provision charged to operations was increased as a result
of higher levels of charge-offs. Total loans charged off during 1998 amounted
to $2.3 million and were primarily made up of consumer indirect automobile
loans. During the second quarter of 1997, the Company began to experience
higher levels of nonperforming consumer loans than anticipated. Management
took immediate measures to implement more stringent underwriting guidelines
associated with these loans.
The Company initiated an indirect lending portfolio in 1995, which grew to
$24.0 million by the end of 1996 and has subsequently declined to $17.8
million at December 31, 1998. As a result of this level of growth coupled
with the knowledge that indirect loans inherently possess a higher degree of
risk of loss than most other loans, management began to increase the provision
for loan losses in the later part on 1996 and continuing in 1997. As the
Company began to experience higher levels of nonperforming indirect loans,
management determined that such loans contained common characteristics and
implemented underwriting guidelines to address those specific issues. A
former officer of the Bank continually circumvented the policies and
12
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procedures initiated and modified to protect asset quality, thereby allowing
loans to be granted that were outside the policy guidelines implemented.
Based on a study of charged-off loans, management believes that there is the
potential for additional losses of approximately $1 million for loans granted
on terms and conditions that were outside the policy established. As such,
management has provided for these potential losses during the 1998 by
increasing the loan loss reserve.
The allowance for loan losses as a percent of total loans increased to 1.63%
at December 31, 1998 from 1.49% at December 31, 1997, while total loans
declined by $1.6 million from $112.4 million at December 31, 1997 to $110.8
million at December 31, 1998. As discussed above, this increase is due to the
increased level of the provision for loan losses coupled with a decline in the
indirect loan portfolio for 1998. The allowance for loan losses as a percent
of nonperforming loans has increased from 64.51% at December 31, 1997 to
105.32% at December 31, 1998. This increase is primarily the result of
management aggressively identifying and charging off those indirect automobile
loans granted on terms and conditions outside of the policy limits
established.
Management uses the aforementioned review and analysis to determine the
adequacy of the allowance for loan losses on a quarterly basis. The provision
for loan losses represents an amount that is intended to be sufficient to
maintain the allowance for loan losses at a level necessary to meet present
and potential risk characteristics of the loan portfolio. Management believes
the allowance for loan losses at December 31, 1998 of $1,803,000 is adequate
to cover losses inherent in the portfolio. However, there can be no
assurances that additional losses will not be sustained in future periods,
which could be substantial in relation to the size of the allowance for loan
losses at December 31, 1998.
The allowance for possible loan losses has been allocated according to the
amount deemed to be reasonably necessary to provide for the possibility of
losses being incurred within the following categories of loans as of the dates
indicated:
The distribution of the Company's allowance for loan losses at the dates
indicated are summarized as follows:
At December 31,
------------------------------------------------------
1998 1997
------------------------------------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
---------- ----------- ---------- -----------
(Dollars in Thousands)
Commercial $ 344 9.26% $ 312 11.92%
Mortgage:
Commercial 187 22.38 555 14.74
One to Four Family 98 42.89 75 40.97
Construction - 0.41 - 0.55
Consumer 1,174 25.06 736 31.82
Unallocated - - - -
---------- ---------- ---------- ----------
Total $ 1,803 100.00% $ 1,678 100.00%
========== ========== ========== ==========
13
<PAGE>
The following table sets forth the amounts and categories of the Company's
non-performing assets at the dates indicated.
At December 31,
-----------------------
1998 1997
---------- ----------
(Dollars in Thousands)
Loans accounted for on a non-accrual basis:
Mortgage loans:
One to four family $ 191 $ 163
Commercial 478 619
Consumer 239 890
Commercial 392 619
---------- ----------
Total non-accrual loans 1,300 2,291
---------- ----------
Accruing loans greater than 90 day past due:
Mortgage loans:
One to four family 138 -
Commercial - -
Consumer 274 311
Commercial - -
---------- ----------
Total accruing loans greater than 90 day past due 412 311
---------- ----------
Total non-performing loans 1,712 2,602
Real estate acquired in settlement of loans - 39
Other non-performing assets 283 -
---------- ----------
Total non-performing assets $ 1,995 $ 2,641
========== ==========
Total non-performing loans to total loans 1.55% 2.31%
========== ==========
Total non-performing loans to total assets 0.99% 1.56%
========== ==========
Total non-performing assets to total assets 1.16% 1.58%
========== ==========
Interest income that would have been recorded on loans accounted for on a
non-accrual basis under the original terms of such loans was $170,057 for the
year ended December 31, 1998 and $43,176 was collected and included in the
Company's interest income from non-accrual loans for the year ended December
31, 1998.
14
<PAGE>
The following table sets forth information with respect to the Bank's
allowance for loan losses at the dates indicated:
At December 31,
-----------------------
1998 1997
---------- ----------
(Dollars in Thousands)
Total loans outstanding $ 110,754 $ 112,429
========== ==========
Average loans outstanding $ 109,132 $ 116,122
========== ==========
Allowance balance (at beginning of period) $ 1,678 $ 1,679
Provision: 2,267 1,250
Charge-offs:
Residential (39) (12)
Consumer (1,899) (1,257)
Commercial (316) (70)
Recoveries:
Residential - -
Consumer 109 84
Commercial 3 4
---------- ----------
Allowance balance (at end of period) $ 1,803 $ 1,678
========== ==========
Allowance for loan losses as a percent
of total loans outstanding 1.63% 1.49%
Net loans charged off as a percent
of average loans outstanding 1.96% 1.08%
Deposits
- --------
Deposits represent the Company's principal source of funds. The deposit base
consists of demand deposits, savings and money market accounts and other time
deposits. During the year, the Company's total deposits grew from $145.4
million in 1997 to $148.9 million in 1998, which equates to an increase of
2.45%. During 1998, the Company introduced a tiered money market product
which attracted local deposits from a variety of competitors, and coupled with
the maturing of certificates of deposit, resulted in an increase of $6,177,000
in money market accounts. Noninterest-bearing demand accounts also benefited
from the maturing of certificates of deposit, as well as an increase in
customers' balances.
15
<PAGE>
The following table represents the average deposits and average rate paid for
the years ended:
At December 31,
----------------------------------------------------
1998 1997
------------------------- -----------------------
Average Rate Average Rate
Amount Paid Amount Paid
Category ----------------------- ----------------------------
- -------- (Dollars in Thousands)
Deposits:
Noninterest-bearing
demand $ 18,680 N/A $ 18,132 N/A
Interest-bearing
demand 8,051 2.42% 7,938 2.42%
Money market 5,705 3.56% 3,749 2.83%
Savings 27,294 2.94% 27,912 2.95%
Time 85,949 5.79% 83,017 5.87%
--------- ---------
Total deposits $ 145,679 $ 140,748
========= =========
The following table indicates the amount of the Company's time deposits of
$100,000 or more by time remaining until maturity as of December 31, 1998.
Maturity Period Time Deposits
--------------- -------------
(In thousands)
Within three months $ 4,500
More than three through six months 1,621
More than six through twelve months 3,557
Over twelve months 3,810
--------
Total $ 13,488
========
Net Interest Income
- -------------------
The most significant source of revenue is net interest income, the amount by
which interest earned on interest-bearing assets exceeds interest expense on
interest-bearing liabilities. Factors which influence net interest income are
changes in volume of interest-bearing assets and liabilities as well as
changes in the associated interest rates.
The Company finances its earning assets with a combination of interest-bearing
and interest-free funds. The interest-bearing funds are composed of deposits,
short-term borrowings and long-term debt. Interest paid for the use of these
funds is the second factor in the net interest income equation. Interest-free
funds, such as demand deposits and stockholders equity, require no interest
expense and, therefore, contribute significantly to net interest income.
Total interest income, which remained relatively stable, was $12.7 million for
1998 as compared to $12.8 million for 1997. This decrease resulted from a
decline in interest income on loans of $781,000 offset somewhat by an increase
in interest income on investments, federal funds sold, and interest bearing
deposits in other banks of $590,000. This slight fluctuation in interest
income is due to a decrease in the average balance of loans of $7.0 million
combined with a 39 basis point decline on interest earning assets (100 basis
points equal 1.0%). These were offset by an increase in the average balance
of investment and mortgage-backed securities, federal funds sold, and
interest-bearing deposits in other banks of $13.2 million. Management
supplemented a lack of loan demand during this time period by primarily
increasing its investment in a variety of long-term mortgage-backed security
products.
16
<PAGE>
Total interest expense amounted to $6.5 million for 1998, representing a 2.59%
increase from $6.3 million for 1997. The increase in interest expense is
primarily due to an increase in the average balance of deposits of $4.4
million combined with an increase in the yield of 73 basis points; both
resulting from the introduction of a tiered money market product in 1998.
The table below sets forth information regarding changes in our interest
income and interest expense for the periods indicated. For each category of
our interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (I) changes in volume (changes in volume
multiplied by old rate) and (ii) changes in rate (changes in rate multiplied
by old volume).
Year Ended December 31
----------------------------------
1998 vs 1997
Increase (Decrease) Due to (1)
-------------------------- -------
Volume Rate Net
---------- ---------- ----------
Interest earned on:
Loans $ (640) $ (141) $ (781)
Taxable investment securities 547 (222) 325
Tax-exempt investment securities 350 (5) 228
Federal funds sold 42 (5) 37
---------- ---------- ----------
Total $ 299 $ (373) $ (191)
========== ========== ----------
Interest paid on:
Demand deposits $ 3 $ - $ 3
Money market accounts 55 42 97
Savings deposits (18) (4) (22)
Time deposits 172 (69) 103
Short - term borrowings 115 (25) 90
Long - term borrowings (107) - (107)
---------- ---------- ----------
Total $ 220 $ (56) $ (164)
========== ========== ----------
GRAND TOTAL $ (355)
==========
(1) The change in interest due to both volume and rate has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of the change in each.
Other Income
- ------------
Other income is primarily made up of service charges on deposit accounts,
investment securities gains and gains on the sale of mortgage loans. Other
income decreased $57,000 or 6.1% from 1997. Factors contributing to this
decrease were fewer service charges transactions, a decline in credit card
merchant fees as the Company is no longer participating in the merchant
segment, and a decline in annuity fee income as a result of lower level of
activity for this product. Management continues to explore new products and
services that could increase other income in future years.
Other Expenses
- --------------
Total other expenses are primarily made up of compensation and employee
benefits, occupancy expenses, professional fees, data processing costs and
other expenses. Total other expenses for 1998 increased $446,000 or 10.41%
over 1997. Salaries and benefits increased $304,000 due to normal pay
increases and an increase in the number of full time equivalent employees of
ten. Occupancy and equipment increased $269,000 as the Company renovated
property in Niles, Ohio to house the operation center,
17
<PAGE>
which opened in November 1998. These added costs of maintaining additional
properties, as well as service contracts relating to the computer systems,
primarily accounted for this increase. Professional fees increased $103,000
in 1998, over 1997 resulting from outside assistance in complying with an
increased level of regulatory compliance for a public reporting company.
Other expenses decreased $246,000 due to smaller dollar decreases in numerous
other expenses. These expenses are subject to increases each year due
primarily to asset growth, increased volume of the operations of the bank and
inflation. Management has adopted a strategy to operate efficiently while
maintaining the highest level of customer service possible. Management will
continue to closely monitor and keep the increases in other expenses to a
minimum in the future.
Liquidity
- ---------
Liquidity is a measure of the Company's ability to efficiently meet normal
cash flow requirements of both borrowers and depositors. To maintain proper
liquidity, the Company uses asset liability management policies along with its
investment policies to assure it can meet its financial obligations to
depositors, credit customers and shareholders. Liquidity is needed to meet
depositors' withdrawal demands, extend credit to meet borrowers' needs,
provide funds for normal operating expenses and cash dividends, and fund other
capital expenditures.
Liquidity management is influenced by cash generated by operating activities,
investing activities and financing activities. The most important source of
funds is the deposits which are primarily core deposits (deposits from
customers with other relationships). Short-term debt from the Federal Home
Loan Bank supplements the Company's availability of funds.
Provision for Income Taxes
- --------------------------
The provision for income taxes decreased $709,000 for 1998 to a benefit of
$100,000 compared to an expense of $609,000 for 1997, due to a decrease in
taxable earnings.
Stockholders' Equity
- --------------------
Stockholders' equity is evaluated in relation to total assets and the risk
associated with those assets. The greater the capital resources, the more
likely a Company is to meet its cash obligations and absorb unforeseen losses.
For these reasons capital adequacy has been, and will continue to be, of
paramount importance.
Stockholders' equity increased to $14,744,000 at December 31, 1998 from
$14,633,000 at December 31, 1997. Adjustments made to stockholders' equity
for unrealized holding gains and losses on available-for-sale securities
resulted in an increase of $127,000 in 1998 over 1997. Retained earnings
decreased due to the decline in net income, and the payment of both cash
dividends of $428,000 and a three percent stock dividend of $724,000. This
decline to stockholders' equity was offset by an increase in common stock of
$262,000 from the reinvestment of dividends through the dividend reinvestment
plan and shares distributed for the stock dividend. Total stockholders' equity
was approximately 8.57% of total assets at December 31, 1998, as compared to
8.75% at December 31, 1997. The dividend rate is determined by the Board of
Directors after considering the Company's capital requirements, current and
projected net income, and applicable governmental regulations and policies.
There are currently three federal regulatory measures of capital adequacy.
The Company's ratios substantially exceed all federal regulatory standards.
Interest Rate and Market Risk Management
- ----------------------------------------
The objective of interest rate sensitivity management is to maintain an
appropriate balance between the stable growth of income and the risks
associated with maximizing income through interest sensitivity imbalances and
the market value risk of assets and liabilities.
Because of the nature of its operations, the Company is not subject to foreign
currency exchange or commodity price risk and, since the Company has no
trading portfolio, it is not subject to trading risk. Currently the Company
has equity securities that represent only 3.65% of its investment portfolio
and, therefore, equity risk is not significant.
18
<PAGE>
The primary components of interest-sensitive assets include adjustable-rate
loans and investments, loan repayments, investment maturities and money market
investments. The primary components of interest-sensitive liabilities include
maturing certificates of deposit, IRA certificates of deposit (individuals
over 59 1/2 have the option of changing their interest rate annually) and
short-term borrowings. Savings deposits, NOW accounts and money market
investor accounts are considered core deposits and are not short-term interest
sensitive.
Loan maturities and rate sensitivity of the loan portfolio, exclusive of real
estate mortgage loans, and consumer installment loans, at December 31, 1998,
are as follows (dollars in thousands):
Within One One to
Year Five Years Total
----------- ----------- -----------
Construction $ 454 $ - $ 454
Commercial, financial,
and agricultural 7,070 3,185 10,255
----------- ----------- -----------
Total $ 7,524 $ 3,185 $ 10,709
=========== =========== ===========
Loans at fixed interest rates $ 1,518 $ 1,527 $ 3,045
Loans at variable interest
rates 6,006 1,658 7,664
----------- ----------- -----------
Total $ 7,524 $ 3,185 $ 10,709
=========== =========== ===========
The following tables set forth a summary of average balances of assets and
liabilities as well as average yield and cost information. Average balances
are derived from daily balances.
<TABLE>
<CAPTION>
December 31
----------------------------------------------------------
1998 (2) 1997 (2)
---------------------------- ----------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
----------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans (1) $109,132 $ 9,855 9.03% $116,122 $ 10,636 9.17%
Taxable investment securities 34,987 2,148 6.14% 26,917 1,823 6.77%
Tax-exempt investment securities 8,060 422 7.93% 3,679 194 7.99%
Federal funds sold 4,253 232 5.45% 3,493 195 5.58%
-------- -------- -------- --------
Total interest-earning assets 156,432 12,657 8.23% 150,211 12,848 8.62%
Noninterest-earning assets 11,972 12,101
-------- --------
$168,404 $162,312
-------- --------
</TABLE>
19
<PAGE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing liabilities:
Demand deposits $ 8,051 $ 195 2.42% $ 7,938 $ 192 2.42%
Money market accounts 5,705 203 3.56% 3,749 106 2.83%
Savings deposits 27,294 802 2.94% 27,912 824 2.95%
Time deposits 85,949 4,974 5.79% 83,017 4,871 5.87%
Short-term borrowings 7,874 318 4.04% 5,231 228 4.36%
Long-term borrowings - - - 1,813 107 5.90%
-------- -------- -------- --------
Total interest-bearing liabilities 134,873 6,492 4.81% 129,660 6,328 4.88%
Noninterest-bearing liabilities 18,848 19,247
Stockholder's equity 14,683 13,405
-------- --------
$168,404 $162,312
======== ========
-------- --------
Net interest income $ 6,165 $ 6,520
======== ========
Net yield on interest-earning
assets (3) 4.08% 4.41%
Interest rate spread (4) 3.42% 3.74%
Ratio of average interest-earning
assets to average interest-
bearing liabilities 115.99% 115.85%
</TABLE>
- ---------------------------
(1) Average balances include non-accrual loans.
(2) Tax equivalent adjustments have been made to yields on loans and
securities that are exempt from federal income tax.
(3) Net yield on interest-earning assets represents net interest income as a
percentage of average interest -earning assets.
(4) Interest rate spread represents the difference between the average yield
on interest-earning assets and the cost of interest-bearing liabilities.
The following table set forth information concerning borrowings during the
periods indicated.
1998 1997
----------------------------
SHORT-TERM BORROWINGS
Ending balance $ 7,649,027 $ 6,523,560
Maximum month-end balance during the year 10,509,123 7,158,445
Average balance during the year 7,867,670 5,068,331
Average year end interest rate 3.47% 4.29%
Average interest rate during the year 4.05% 4.23%
20
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY.
(a) PROPERTY. The Bank owns and operates its main office at 1 South Main
Street in Niles, Ohio. The Bank also operates six branches. The
following is a breakdown of the branch offices owned:
Branches Owned:
- --------------
Downtown Niles Drive-In Girard Office
Corner of Church & State Sts. 121 North State St.
Niles, OH 44446 Girard, OH 44420
422 Office Mineral Ridge Office
5845 Youngstown-Warren Rd. 3826 Main Street
Niles, OH 44446 Mineral Ridge, OH 44440
Youngstown Road Office
2910 Youngstown Road
Warren, OH 44484
(b) INVESTMENT POLICIES. See "Item 1. Description of Business" above for
a general description of the Bank's investment policies and any
regulatory or Board of Directors' percentage of assets limitations
regarding certain investments. The Bank's investments are primarily
acquired to produce income, and to a lesser extent, possible capital
gain.
(1) INVESTMENTS IN REAL ESTATE OF INTEREST IN REAL ESTATE. See "Item
1. Description of Business - Loans and - Certain Regulatory Considerations,"
and "Item 2. Description of Property."
(2) INVESTMENTS IN REAL ESTATE MORTGAGES. See "Item 1. Description
of Business - Loans and - Certain Regulatory Considerations."
(3) INVESTMENTS IN SECURITIES OF OR INTERESTS IN PERSONS PRIMARILY
ENGAGED IN REAL ESTATE ACTIVITIES. See "Item 1. Description of Business -
Loans and - Certain Regulatory Considerations."
(c) DESCRIPTION OF REAL ESTATE AND OPERATING DATA.
Not Applicable.
ITEM 3. LEGAL PROCEEDINGS.
There is no pending litigation which, in the opinion of management, will
adversely impact the financial condition of the Company or the Bank. There is
litigation threatened by a bank customer which has not been initiated as of
the preparation of this offering circular. In the event that the threatened
litigation is initiated, management and its counsel do not believe that any
loss other than those associated with the collection process shall be
incurred. Consequently, it is the opinion of management that the threatened
litigation shall not have a material adverse impact upon the financial
condition of the Company and the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year.
21
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information contained under the section captioned "Stock Market
Information" of the Company's Annual Report to Stockholders for the fiscal
year ended December 31, 1998 (the "Annual Report") is incorporated herein by
reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
The information contained in the section captioned "Management's
Discussion and Analysis" in the Annual Report is incorporated herein by
reference.
ITEM 7. FINANCIAL STATEMENTS.
The Registrant's financial statements listed under Item 13 are
incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANT'S ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The information contained in the section captioned "Selection of
Auditors" in the Company's 1998 definitive proxy statement for the Company's
1998 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated
herein by reference.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information contained under the sections captioned "Compliance with
Section 16(a) of the Securities Exchange Act of 1934" and "Proposal for the
Election of Directors and Information with Respect to Directors and Officers -
Information with Respect to Nominees," "Information with Respect to Directors
not Standing for Reelection" and "Security Ownership of Management" in the
Proxy Statement is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information contained in the section captioned "Proposal for the
Election of Directors and Information with Respect to Directors and Officers -
Committees and Compensation of the Board of Directors" and "Executive
Compensation and Other Information" in the Proxy Statement is incorporated
herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) Security Ownership of Certain Beneficial Owners
Information required by this items is incorporated herein by reference
in the section captioned "Voting Securities and Principal Holders
Thereof" in the Proxy Statement.
22
<PAGE>
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to
the chart in the section captioned "Proposal for the Election of
Directors and Information with Respect to Directors and Officers -
Information with Respect to Nominees" and "Security Ownership of
Management" in the Proxy Statement.
(c) Management of the Registrant knows of no arrangement, including
any pledge by any person of securities of the Registrant, the operation
of which may at a subsequent date result in a change in control of the
Registrant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by
reference to the section captioned "Executive Compensation and Other
Information - Certain Relationships and Related Transactions" in the
Proxy Statement.
ITEM 13. EXHIBITS, LIST, AND REPORTS ON FORM 8-K.
(a) Listed below are all financial statements and exhibits filed as
part of this report.
1. The consolidated balance sheets of Security Financial Corp.
as of December 31, 1998 and 1997 and the related consolidated
statements of income, changes in stockholders' equity and
cash flows for each of the years in the two years ended
December 31, 1998, together with the related notes and the
independent auditors' report of S.R. Snodgrass, A.C.
independent certified public accountants.
2. Schedules omitted as they are not applicable.
3. The following exhibits are included in this Report or
incorporated herein by reference:
(a) List of Exhibits:
13 1998 Annual Report to Stockholders
16 Letter on Change of Certifying Accountants *
21 Subsidiaries of the Registrant (See "Item 1
-Description of Business")
27 Financial Data Schedule (electronic filing only)
- ------------------------
* Incorporated by reference to the Form 8-K (File No. 99555528) filed with
the SEC on February 25, 1999.
23
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Security Financial Corp.
(Registrant)
Date: March 15, 1999 By: /s/ Glenn Griffiths
---------------------------------
Glenn Griffiths,
President & CEO
Date: March 15, 1999 By: /s/ Donald Stacy
---------------------------------
Donald Stacy,
Vice President &
Treasurer
Date: March 15, 1999 By: /s/ Gary A. Clayman
---------------------------------
Gary A. Clayman,
Director
Date: March 15, 1999 By: /s/ Robert I. Griffith, Jr.
---------------------------------
Robert I. Griffith, Jr.,
Director
Date: March 15, 1999 By: /s/ Robert J. McClurkin
---------------------------------
Robert J. McClurkin,
Director
Date: March 15, 1999 By: /s/ Douglas J. Neuman
---------------------------------
Douglas J. Neuman,
Director
24
<PAGE>
Date: March 15, 1999 By: /s/ Peter P. Rossi, Jr.
---------------------------------
Peter P. Rossi, Jr.,
Director
Date: March 15, 1999 By: /s/ Christopher J. Shaker
---------------------------------
Christopher J. Shaker,
Director
25
<PAGE>
Directors and Officers
Security Financial Corp. and Subsidiary
Board of Directors of Security Financial Corp.
And The Security Dollar Bank
Gary A. Clayman Robert I. Griffith, Jr.
Glenn E. Griffiths Rober J. McClurkin
Douglas J. Neuman
Christopher J. Shaker - Chairman
Peter P. Rossi, Jr. - Vice Chairman
Officers of Security Financial Corp.
Glenn E. Griffiths Donald L. Stacy Dorothy M. Farmer
President/CEO Treasurer Senior Vice President
Officers of Security Dollar Bank
Glenn E. Griffiths Donald L. Stacy Fremont J. Camerino
President/CEO Senior Vice President & Treasurer Secretary
Kevin T. Lamar Phillip M. Suarez Dorothy M. Farmer Robert E. True
Vice President Senior Vice President Secretary Vice President
Senior Loan Head of Lending Business
Officer Development
Richard G. Ferraro Richard R. Lytle Janet Ulery Randall L. Gilroy
Vice President Assistant Vice Manager Assistant Vice
& Loan Officer President Main Office President
Manager Commercial
422 Office Lending
Paul D. Rhodes Bruce Bryant Denis Preston James G. Swift
Assistant Vice Assistant Vice Compliance Assistant Vice
President President Manager President
Collection Dept. Loan Operations EDP Manager
Officer
Kevin Helmick Mary Jane Naples Dawn J. Field Patricia A. Baker
Financial Operations Manager Manager
Services Officer Youngstown Rd. Credit
Office Department
Rose Ann Lubert Armeta E. Cordell R. Keith Price Deborah N. Testa
Manager Assistant Assistant Vice Manager
Girard Office Secretary President Mineral Ridge
Human Resources Office
3
<PAGE>
Brief Description of Business
Security Financial Corp. and Subsidiary
SECURITY FINANCIAL CORP.
Security Financial Corp. (the "Corporation") is a one-bank holding
company formed under the Bank Holding company Act of 1956, as amended,
operating under regulations of the Board of Governors of the Federal Reserve
System. Its principal subsidiary is The Security Dollar Bank of Niles, which
was acquired March 31, 1988. Presently the Corporation and its subsidiary
operate in one industry, domestic banking.
The Corporation conducts no business activities except for investments in
securities permitted under the Bank Holding company Act. The Board of
Directors of the Corporation and the Bank are identical. The officers of the
Corporation are Glenn E. Griffiths, President/CEO; Donald L. Stacy, Treasurer;
and Dorothy M. Farmer, Secretary.
Bank holding companies are permitted under Regulation Y of the Board of
Governors of the Federal Reserve System to engage in other activities
considered closely related to banking such as leasing and mortgage banking.
The Corporation has no other subsidiaries engaged in such activities at this
time.
THE SECURITY DOLLAR BANK
The Bank is a full services state-chartered bank engaged in commercial
and retail banking with the exception of trust services. The Bank's
commercial banking services include checking accounts, savings accounts, time
deposit accounts, commercial, mortgage, installment and home equity loans,
night depository, automatic 24-hour teller machines, safe deposit boxes, money
orders, travelers checks, government bond sales, utility bill payments, IRA
accounts, MasterCard and Visa Credit Cards and other services normally offered
by commercial banks.
The Bank's main office is located at 1 South Main Street, Niles, Ohio.
Business is conducted at a total of five(5) offices located in Trumbull
County. As a state banking association and member of the Federal Reserve
System, the Bank is subject to supervision and regulation by the Ohio Division
of Banks and the Federal Reserve Bank of Cleveland. Deposits are insured by
the Federal Deposit Insurance Corporation (FDIC) to the extent provided by
law.
As of December 31, 1998, the Corporation and its subsidiary had 100 full
and part-time employees, and consider its relations with its employees to be
satisfactory.
4
<PAGE>
Selected Financial Information
The following table sets forth certain information concerning the consolidated
financial position of the Company at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands, except shares and per share data)
<S> <C> <C> <C> <C> <C>
Statement of Income:
Interest income $ 12,657 $ 12,848 $ 11,269 $ 8,995 $ 7,380
Interest expense 6,492 6,328 5,457 4,243 2,949
Net interest income 6,165 6,520 5,812 4,752 4,431
Provision for loan losses 2,267 1,250 668 198 290
Net interest income after
provision for loan losses 3,898 5,270 5,144 4,554 4,141
Investment securities gains, net 51 25 26 22 21
Other noninterest income 834 916 801 728 707
Other noninterest expense 4,730 4,284 4,186 3,832 3,421
Federal income tax expense (benefit) (100) 609 543 422 427
----------------------------------------------------------------
Net Income $153 $1,318 $1,241 $1,049 $1,020
================================================================
Per share of common stock (1):
Net income $.44 $4.01 $4.35 $3.76 $3.82
Dividends 1.24 1.12 .97 0.87 0.66
Book value 42.49 42.64 37.46 34.42 30.60
Average common shares outstanding 344,669 320,732 277,408 271,219 259,597
Year-end balances:
Loans receivable, net $108,952 $110,751 $113,310 $81,988 $66,370
Investment securities available
for sale 44,360 41,639 26,691 18,737 17,782
Total assets 172,074 167,258 152,899 127,064 107,880
Cash and cash equivalents 10,733 8,906 6,868 6,189 7,298
Deposits 148,917 145,352 129,670 109,571 94,188
Borrowings 7,649 6,524 11,754 7,246 4,974
Stockholder's equity 14,744 14,633 10,779 9,789 8,388
</TABLE>
5
<PAGE>
Selected Financial Information (Continued)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
KEY OPERATING RATIOS:
Return on average assets (net income
divided by average total assets) 0.09 0.81 0.86 0.90 1.00
Return on average equity (net income
divided by average equity) 1.04 9.83 12.14 12.51 13.73
Dividend Payout Ratio (dividends
declared per share divided by net
income per share) 281.81 27.98 22.35 23.26 17.30
Equity to assets ratio (average equity
divided by average total assets) 8.72 8.26 7.12 7.19 7.28
Allowance for loan losses to
nonperforming loans 105.32 64.51 85.75 236.45 167.18
</TABLE>
- -------------------------------------
(1) All share and per share data has been restated for the effect of common
stock dividends and splits.
<PAGE>
Stock Market Information
There is no established public trading market for the Company's common stock
and the shares of the Company are not listed on any exchange. Sale price
information is based on information reported to the Company by individual
buyers and sellers of the Company stock. The following table summarizes the
high and low prices and dividend information for 1998 and 1997, adjusted for a
three percent stock dividend on December 14, 1998. Cash dividends are paid on
a semi-annual basis.
Cash
Dividends
Quarter Ended High Low Paid
- ----------------------- ----- ----- ----
1998 March 31 68.59 65.16 .32
June 30 68.76 68.59 .32
September 30 71.32 68.76 .32
December 31 71.66 71.32 .32
1997 March 31 54.00 54.00 .28
June 30 59.12 54.00 .28
September 30 60.31 59.12 .28
December 31 65.16 60.31 .31
At December 31, 1998 the Company had approximately 576 stockholders of record.
6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION
- -------------------
Total assets amounted to $172,074,000 at December 31, 1998, an increase of
$4,816,000 or 2.9% from $167,258,000 at December 31, 1997. A $3,564,000
increase in deposits and a $1,125,000 increase in short-term borrowings funded
the increase in assets.
Short-term liquid investments consisting of cash and due from banks, federal
funds sold, and interest-bearing deposits in other banks, increased in the
aggregate by $2,225,000 or 25.0% primarily the result of a decline in loans
coupled with principal repayments of mortgage-backed securities.
Investment securities increased $2,721,000, or 6.5%, to $44,360,000 at
December 31, 1998 from $41,639,000 at December 31, 1997. Throughout the year
as funds became available from deposits and the maturity of investment
securities, the Company expanded its concentration of the investment portfolio
in mortgage-backed securities by replacing a significant portion of U.S.
Treasury and Government agency securities with higher yielding mortgage-backed
securities. Typically, these securities have maturities ranging from 10 to 25
years.
Net loan receivables decreased $1,799,000 or 1.6% from $110,751,000 at
December 31, 1997 to $108,952,000 at December 31, 1998. During 1998, there
was a strong demand for commercial real estate loans, which generated
approximately $8,226,000 in loan growth; however, more than offsetting this
increase was a decline in the installment loan portfolio and more specifically
in the indirect automobile loan portfolio. As discussed below, the Company
has experienced significant loan losses in relation to this portfolio and
management has been stringently enforcing existing underwriting guidelines,
which has resulted in a reduction in loan originations. Indirect automobile
loans have a three to five year average life and the repayment of these loans
have outpaced the new loan origination's during the current period.
Net office properties and equipment increased $1,135,000 or 29.6%. This is
directly related to new operations center, and related equipment, located in
Niles, Ohio which opened in November 1998. This facility houses the mainframe
computer, bookkeeping, and accounting operations of the Company.
Deposits increased by $3,564,000, or 2.4%, to $148,917,000 at December 31,
1998 from $145,352,000 at December 31, 1997. This increase represents
increases in money market deposit accounts and noninterest-bearing demand
deposit accounts of $6,177,000 and $3,131,000, respectively, while being
offset by a decline of $5,309,000 in certificates of deposit. During 1998 a
new tiered money market product was offered which resulted in a fluctuation in
the deposit portfolio mix from certificates of deposit to money market
deposits.
Short-term borrowings increased $1,125,000, or 17.2%, from $6,524,000 at
December 31, 1997 to $7,649,000 at December 31, 1998. The increase is a
result of an increase in repurchase agreements. Management believes such
accounts are a stable source of funds as they represent substitutes for core
deposits for larger commercial and governmental agency customers.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
FINANCIAL CONDITION (Continued)
- -------------------
Equity capital increased by $111,000 for the year ended December 31, 1998, as
a result of the net income of $153,000, the purchase of shares of common stock
through the dividend reinvestment plan of $262,000, and an increase in the net
unrealized gain on securities of $127,000. These increases were offset by
dividend payments of $431,000. Through December 31, 1998, the Company
initiated the payment of dividends of $1.24 per share, while maintaining
capital ratios well in excess of regulatory guidelines. The Board of
Directors will determine future dividend policies in light of the earnings and
financial condition of the Company including applicable governmental
regulations and policies.
RESULTS OF OPERATIONS
- ---------------------
Comparison of results from operations from December 31, 1998 to December 31,
1997.
Net income declined by $1,166,000 to $153,000 or $.44 per share. Net income
declined as a result of declines in net interest income of $354,000 and other
income of $57,000 and increases in provisions for loan losses of $1,017,000
and other expenses of $446,000, offset by a reduction in income taxes of
$709,000.
Net Interest Income
- -------------------
Net interest income decreased $354,000, or 5.4%, to $6,165,000 for the year
ended December 31, 1998 compared to $6,328,000 for the year ended 1997.
Interest income decreased by $191,000 while interest expense increased by
$163,000.
The decrease in interest income resulted primarily from a decrease in earnings
on loans of $781,000 or 7.3%, offset by an increase in interest income on
investments, federal funds sold and interest bearing deposits in other banks
amounting to $590,000. The decrease in interest income on loans was due to a
decrease in the average principal balances for loans of $7.0 million coupled
with a slight decline in the yields on loans. The increase in other interest
income resulted from increases in average balances totaling $13.2 million
offset by a 52 basis point decline in yield. The lack of loan demand during
the year was supplemented by investment in mortgage-backed securities at a
lower yield.
Interest expense on deposits increased by $182,000. This increase results
from an increased average balance for the period of $4.4 million and an
increase in the yield of 73 basis points on money market deposit accounts from
the new tiered money market product.
The following table sets forth information regarding changes in our interest
income and interest expense for the periods indicated. For each category of
our interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (changes in volume
multiplied by old rate), (ii) changes in rate (changes in rate multiplied by
old volume), and (iii) the change in interest due to both volume and rate,
which has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net Interest Income (Continued)
- -------------------
Year Ended December 31
------------------------------------
1998 vs 1997
Increase (Decrease) Due to (1)
------------------------------------
Volume Rate Net
------------------------------------
Interest earned on:
Loans $ (640) $ (141) $ (781)
Taxable investment securities 547 (222) 325
Tax-exempt investment securities 350 (5) 228
Federal funds sold 42 (5) 37
------- ------- -------
Total $ 299 $ (373) $ (191)
======= ======= =======
Interest paid on:
Demand deposits 3 - 3
Money market accounts 55 42 97
Savings deposits (18) (4) (22)
Time deposits 172 (69) 103
Short-term borrowings 115 (25) 90
Long-term borrowings (107) - (107)
------- ------- -------
Total $ 220 $ (56) $ 164
======= ======= =======
GRAND TOTAL $ (355)
=======
(1) The change in interest due to both volume and rate 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
- -------------------------
During 1997 and 1998 the Company's earnings have been adversely effected by
significant provisions for loan losses. In 1995 the Company initiated an
indirect automobile loan program within its immediate market area. This
program experienced significant growth in 1996 and continued through May 1997.
During this period, management and the Board of Directors initiated and
modified certain policies and procedures to protect asset quality in this
volatile industry. A former officer of the Bank continually circumvented the
policies and procedures initiated and modified to protect asset quality,
thereby allowing loans to be granted that were outside the policy guidelines
implemented. The significant provisions for loan losses recorded in 1997 and
1998 have primarily been attributed to the indirect automobile loans.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Provision for Loan Losses (Continued)
- -------------------------
Management has been monitoring and continually implementing additional control
procedures to protect asset quality. Management has performed a recent study,
which indicates that 93% of all automobile repossession have occurred in loans
that were granted on terms and conditions that were outside of the policy
limits established, resulting in approximately $1.5 million in losses. These
losses were provided for from current earnings of the Company, which reduced
the earnings for 1997 and 1998. Based on this study, management believes
there is the potential for additional losses on such loans of approximately
$1,000,000 and has provided for these potential losses in the third quarter of
1998 by increasing the loan loss reserve accordingly. The recent provision to
the loan loss reserve will fund the losses if and when they occur in the
future.
The former officer of the Bank was dismissed in 1997 and the Company has filed
civil litigation against this individual along with others who were believed
to be involved with these transactions. The Company has also initiated a
claim with its blanket bond insurance carrier asserting wrongful conduct on
part of the Bank Officer in making these loans. The Board of Directors
intends to pursue both these actions vigorously to recover losses realized and
to recover any future chargeoffs that may occur in association with the loans
granted outside the limitations established by the Board of Directors.
The Company has continued to participate in the indirect dealer automobile
loan market as it provides a desired product in the market it serves. The
Company has originated $6.1 million in indirect automobile loans since August
1997. These loans have a remaining outstanding balance of approximately $4.8
million and as of December 31, 1998, are experiencing an $18,000 delinquency
30 days past due and no chargeoffs.
Management's evaluation of the allowance for loan losses encompasses the
overall risk characteristics of the various portfolio segments, past
experience with losses, the impact of economic conditions on borrowers, and
other relevant factors. The provision for loan losses increased by $1.0
million for the year ended December 31, 1998 compared to the same period ended
1997.
Other Income
- ------------
Noninterest income, which is comprised principally of service charges on
deposit accounts, decreased $57,000 or 6.1%. Service charges on deposit
accounts decreased $39,000, a result of fewer transactions requiring service
charges. Other income decreased $75,000 or 33.0% primarily due to a $45,000
decline in credit card merchant fees as the Company is no longer participating
in the merchant segment and a $35,000 decline in annuity fee income as a
result of lower level of activity in this product
Other Expenses
- --------------
Noninterest expense overall increased by $446,000, or 10.4%, from $4,284,000
for the year ended December 31, 1997 compared to $4,730,000 for the year ended
December 31, 1998. There was an increase in salaries and employee benefits of
$304,000 or 13.3%. This increase is the result of normal pay increases
coupled with an increase in the number of full time equivalent employees of
ten in 1998. The increase in full time equivalent employees is considered
normal considering the growth of the Company of the past two years.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Other Expenses (Continued)
- --------------
Occupancy expense increased by $269,000, or 63.1%, a combined result of added
costs of additional properties and service contracts relating to the computer
systems. The Company has acquired and remodeled a property in Niles, Ohio to
house the operation center, which opened in November 1998.
Other expense decreased $246,000 for the year ended December 31, 1998 compared
to the same period ended 1997. Professional fees increased $103,000 due to
outside assistance in complying with increased levels of regulatory compliance
of a public reporting company. There was also an increase of Ohio intangible
tax of $40,000 due to due to an increase in stockholders' equity resulting
from a stock offering in 1997, as well as 1997 net income. These increases
were offset by smaller dollar decreases in numerous other expenses.
Provision for Income Taxes
- --------------------------
Income tax expense decreased $709,000 to a benefit of $100,000 for the year
ended December 31, 1998 compared to a expense of $609,000 for the year ended
December 31, 1997 due to the decrease in pre-tax income.
Liquidity
- ---------
Liquidity is a measure of the Company's ability to efficiently meet normal
cash flow requirements of both borrowers and depositors. To maintain proper
liquidity, the Company uses asset liability management policies along with its
investment policies to assure it can meet its financial obligations to
depositors, credit customers and shareholders. Liquidity is needed to meet
depositors' withdrawal demands, extend credit to meet borrowers' needs,
provide funds for normal operating expenses and cash dividends, and fund other
capital expenditures.
Liquidity management is influenced by cash generated by operating activities,
investing activities and financing activities. The most important source of
funds is the deposits which are primarily core deposits (deposits from
customers with other relationships). Short-term debt from the Federal Home
Loan Bank supplements the Company's availability of funds.
Year 2000 Compliance
- --------------------
During fiscal 1998, the Company adopted a Year 2000 Compliance Plan (the
"Plan") and established a Year 2000 Compliance Committee (the "Committee").
The objectives of the Plan and the Committee are to prepare the Company for
the millennium. As recommended by the Federal Financial Institutions
Examination Council, the Plan encompasses the following phases: Awareness,
Assessment, Renovation, Validation, and Implementation. These phases will
enable the Company to identify risks, develop an action plan, perform adequate
testing, and complete certification that its processing systems will be Year
2000 ready. Execution of the Plan is currently on target. The Company is
currently in Phase 4, Validation (which includes testing of incremental
changes to hardware and software, testing connections with third-party
vendors, and establishing controls to ensure timely completion of all hardware
and software prior to final implementation). Prioritization of the most
critical applications has been addressed, along with contract and service
agreements.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Year 2000 Compliance (Continued)
- --------------------
The primary operating software for the Company is obtained and maintained by
an external provider of software (the "External Provider"). The Company has
maintained ongoing contact with this vendor so that modification of the
software is a top priority and has been completed. The Company has contacted
all other material vendors and suppliers regarding their Year 2000 readiness.
Each of these third parties has delivered written assurance to the Company
that they expect to be Year 2000 compliant prior to the Year 2000. The
Company has contacted material customers and non-information technology
suppliers (i.e., utility systems, telephone systems, and security systems)
regarding their Year 2000 state of readiness. The Validation phase is
targeted for completion by March 31, 1999. The Implementation phase is to
certify that systems are Year 2000 ready, along with the assurances that any
new systems are compliant on a going forward basis. The implementation phase
is targeted for completion by June 30, 1999.
The Company expects to incur internal staffing costs as well as consulting and
other expenses related to testing and enhancements to prepare the systems for
the Year 2000. The Company does not anticipate that the related costs will be
material in any single year. In total, the Company estimates that its cost
for compliance will amount to approximately $80,000 over the two-year period
from 1998 to 1999. A significant portion of these costs are not likely to be
incremental costs to the Company but rather the redeployment of existing
resources. As of December 31, 1998, the Company estimates that approximately
$30,000 of these costs have been incurred. No assurance can be given that the
Year 2000 Compliance Plan will be completed successfully by the Year 2000, in
which event the Company could incur significant costs. If the External
Provider is unable to resolve the potential problem in time, the Company would
likely experience significant data processing delays, mistakes, or failures.
These delays, mistakes, or failures could have a significant adverse impact on
the financial statements of the Company.
Successful and timely completion of the Year 2000 project is based on
management's best estimates derived from various assumptions of future events,
which are inherently uncertain including the progress and results of the
Company's External Provider, testing plans, and all vendors, suppliers, and
customer readiness.
Interest Rate and Market Risk Management
- ----------------------------------------
The objective of interest rate sensitivity management is to maintain an
appropriate balance between the stable growth of income and the risks
associated with maximizing income through interest sensitivity imbalances and
the market value risk of assets and liabilities.
Because of the nature of its operations, the Company is not subject to foreign
currency exchange or commodity price risk and, since the Company has no
trading portfolio, it is not subject to trading risk. Currently the Company
has equity securities that represent only 2.73% of its investment portfolio
and, therefore, equity risk is not significant.
The primary components of interest-sensitive assets include adjustable-rate
loans and investments, loan repayments, investment maturities and money market
investments. The primary components of interest-sensitive liabilities include
maturing certificates of deposit, IRA certificates of deposit (individuals
over 59-1/2 have the option of changing their interest rate annually) and
short-term borrowings. Savings deposits, NOW accounts, and money market
investor accounts are considered core deposits and are not short-term interest
sensitive.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Average Balance Sheet and Interest Rate Analysis
- ------------------------------------------------
The following table sets forth a summary of average balances of assets and
liabilities as well as average yield and cost information. Average balances
are derived from daily balances.
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------
1998 (2) 1997 (2)
----------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans(1) $109,132 $ 9,855 9.03% $116,122 $ 10,636 9.17%
Taxable investment securities 34,987 2,148 6.14% 26,917 1,823 6.77%
Tax-exempt investment
securities 8,060 422 7.93% 3,679 194 7.99%
Federal funds sold 4,253 232 5.45% 3,493 195 5.58%
-------- -------- ----- -------- -------- -----
Total interest-earning assets 156,432 12,657 8.23% 150,211 12,848 8.62%
Noninterest-earning assets 11,971 12,101
-------- --------
$168,404 $162,312
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Demand deposits $ 8,051 195 2.42% $ 7,938 $ 192 2.42%
Money market accounts 5,705 203 3.56% 3,749 106 2.83%
Savings deposits 27,294 802 2.94% 27,912 824 2.95%
Time deposits 85,949 4,974 5.79% 83,017 4,871 5.87%
Short-term borrowings 7,874 318 4.04% 5,231 228 4.36%
Long-term borrowings - - - 1,813 107 5.90%
-------- -------- ----- -------- -------- -----
Total interest-bearing liabilities 134,873 6,492 4.81% 129,660 6,328 4.88%
Noninterest-bearing liabilities 18,848 19,247
Shareholders' equity 14,683 13,405
-------- --------
$168,404 $162,312
======== ========
Net interest income $ 6,165 $ 6,520
-------- --------
Net yield on interest-earning assets (3) 4.08% 4.41%
Interest rate spread (4) 3.42% 3.74%
Ratio of average interest-earning
assets to average interest-
bearing liabilities 115.99% 115.85%
- ---------------------------------------
</TABLE>
(1) Average balances include nonaccrual loans.
(2) Tax equivalent adjustments have been made to yields on loans and
securities that are exempt from federal income tax.
(3) Net yield on interest-earning assets represents net interest income as
a percentage of average interest-earning assets.
(4) Interest rate spread represents the difference between the average yield
on interest-earning assets and the cost of interest-bearing
liabilities.
13
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Security Financial Corp.
We have audited the accompanying consolidated balance sheet of Security
Financial Corp. and subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity,
and cash flows for the years then ended. These financial statements are the
responsibility of the Company'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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Security Financial Corp. and subsidiary as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for the years then
ended in conformity with generally accepted accounting principles.
/s/ S.R. Snodgrass, A.C.
Wexford, PA
January 22, 1999
14
<PAGE>
SECURITY FINANCIAL CORP.
CONSOLIDATED BALANCE SHEET
December 31,
1998 1997
------------ ------------
ASSETS
Cash and due from banks $ 8,056,009 $ 7,416,457
Federal funds sold 1,781,000 1,090,000
Interest-bearing deposits in other banks 1,294,000 400,000
Investment securities available for sale 44,359,814 41,638,502
Loans 110,754,928 112,428,694
Less allowance for loan losses 1,802,773 1,677,651
------------ ------------
Net loans 108,952,155 110,751,043
Premises and equipment 4,967,839 3,833,325
Accrued interest and other assets 2,662,963 2,128,857
TOTAL ASSETS $ 172,073,780 $ 167,258,184
============ ============
LIABILITIES
Deposits:
Noninterest-bearing demand $ 21,178,516 $ 18,047,213
Interest-bearing demand 7,980,918 7,873,059
Money market 10,194,276 4,017,442
Savings 26,576,390 27,119,276
Time 82,986,786 88,295,471
------------ ------------
Total deposits 148,916,886 145,352,461
Short-term borrowings 7,649,027 6,523,560
Accrued interest and other liabilities 763,587 749,280
------------ ------------
TOTAL LIABILITIES 157,329,500 152,625,301
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, no par value; 1,500,000 shares
authorized; 346,978 and 333,164 shares issued 6,794,102 832,910
Capital surplus - 4,977,246
Retained earnings 7,695,892 8,695,696
Net unrealized gain on securities 254,286 127,031
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 14,744,280 14,632,883
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 172,073,780 $ 167,258,184
============ ============
See accompanying notes to the consolidated financial statements.
15
<PAGE>
SECURITY FINANCIAL CORP.
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31,
1998 1997
------------ ------------
INTEREST INCOME
Interest and fees on loans $ 9,855,641 $ 10,636,250
Interest-bearing deposits in
other banks 32,701 19,924
Federal funds sold 231,838 195,028
Investment securities:
Taxable 2,115,073 1,802,521
Exempt from federal income tax 421,742 194,081
----------- -----------
Total interest income 12,656,995 12,847,804
----------- -----------
INTEREST EXPENSE
Deposits 6,173,623 5,991,240
Short-term borrowings 318,388 230,862
Other borrowings - 106,253
----------- -----------
Total interest expense 6,492,011 6,328,355
----------- -----------
NET INTEREST INCOME 6,164,984 6,519,449
PROVISION FOR LOAN LOSSES 2,267,000 1,250,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,897,984 5,269,449
----------- -----------
OTHER INCOME
Service charges on deposit accounts 595,678 634,197
Investment securities gains, net 51,167 25,250
Gain on sales of mortgage loans, net 46,428 62,356
Other income 191,379 219,918
----------- -----------
Total other income 884,652 941,721
----------- -----------
OTHER EXPENSE
Salaries and employee benefits 2,590,383 2,286,155
Occupancy and equipment expense 695,417 426,434
Other expense 1,443,912 1,571,014
----------- -----------
Total other expense 4,729,712 4,283,603
----------- -----------
Income before income taxes 52,924 1,927,567
Income tax expense (benefit) (99,884) 609,119
----------- -----------
NET INCOME $ 152,808 $ 1,318,448
=========== ===========
EARNINGS PER SHARE:
Basic $ 0.44 $ 4.01
Diluted 0.44 4.01
See accompanying notes to the consolidated financial statements.
16
<PAGE>
<TABLE>
<CAPTION>
SECURITY FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Net
Unrealized
Common Capital Retained Gain on Comprehensive
Stock Surplus Earnings Securities Total Income
----------- ----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 698,556 $ 2,306,650 $ 7,753,555 $ 20,062 $ 10,778,823
Net income 1,318,448 1,318,448 $ 1,318,448
Other comprehensive income:
Unrealized gain on available for sale
securities, net of reclassification adjustment 106,969 106,969 106,969
-----------
Comprehensive income $ 1,425,417
===========
Cash dividends ($1.12 per share) (376,307) (376,307)
Proceeds from the sale of stock 125,000 2,456,682 2,581,682
Dividend reinvestment and stock purchase plan 9,354 213,914 223,268
----------- ----------- ----------- ----------- ------------
Balance, December 31, 1997 832,910 4,977,246 8,695,696 127,031 14,632,883
Reclassification for change to no par
common stock 4,977,246 (4,977,246) -
Net income 152,808 152,808 $ 152,808
Other comprehensive income:
Unrealized gain on available for sale
securities, net of reclassification adjustment 127,255 127,255 127,255
-----------
Comprehensive income $ 280,063
===========
Cash dividends ($1.24 per share) (428,265) (428,265)
Dividend reinvestment and stock purchase plan 262,156 262,156
Three percent stock dividend including
fractional shares cash paid 721,790 (724,347) (2,557)
----------- ----------- ----------- ----------- ------------
Balance, December 31, 1998 $ 6,794,102 $ - $ 7,695,892 $ 254,286 $ 14,744,280
=========== =========== =========== =========== ============
1998 1997
---------- ----------
Components of comprehensive income:
Change in net unrealized gain on investment
securities available for sale $ 161,025 $ 123,634
Realized gains included in net income, net of tax (33,770) (16,665)
---------- ----------
Total $ 127,255 $ 106,969
========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
17
<PAGE>
SECURITY FINANCIAL CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31,
1998 1997
----------- -----------
OPERATING ACTIVITIES
Net income $ 152,808 $ 1,318,448
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 1,095,568 831,903
Investment securities gains, net (51,167) (25,250)
Provision for loan losses 2,267,000 1,250,000
Deferred federal income taxes 51,854 38,367
Mortgage loans originated for sale (2,402,039) (3,299,045)
Proceeds from sales of mortgage loans 2,448,467 3,361,401
Gain on sales of mortgage loans, net (46,428) (62,356)
Increase in accrued interest receivable (27,329) (117,057)
Increase (decrease) in accrued
interest payable (45,849) 74,518
Other, net (214,340) (91,180)
----------- -----------
Net cash provided by
operating activities 3,228,545 3,279,749
----------- -----------
INVESTING ACTIVITIES
Decrease (increase) in interest-bearing
time deposits in other banks (398,000) 205,000
Investment securities available for sale:
Proceeds from sales 4,365,457 6,724,900
Proceeds from maturities and
principal repayments 12,165,746 3,053,702
Purchases (19,480,782) (24,750,170)
Net decrease (increase) in loans (1,379,969) 1,009,384
Purchase of premises and equipment (1,447,700) (366,309)
Proceeds from sale of repossessed assets 253,212 -
----------- -----------
Net cash used for investing activities (5,922,036) (14,123,493)
----------- -----------
FINANCING ACTIVITIES
Net increase in deposits 3,564,425 15,682,763
Net increase in short-term borrowings 1,124,341 170,255
Repayment of other borrowings - (5,400,000)
Dividends paid on common stock (430,822) (376,307)
Proceeds from sale of common stock - 2,581,682
Proceeds from dividend reinvestment
and stock purchase plan 262,156 223,268
----------- -----------
Net cash provided by
financing activities 4,520,100 12,881,661
----------- -----------
Increase in cash and cash equivalents 1,826,609 2,037,917
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 8,906,400 6,868,483
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $10,733,009 $ 8,906,400
=========== ===========
See accompanying notes to the consolidated financial statements.
18
<PAGE>
SECURITY FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting and reporting policies applied in the
presentation of the accompanying financial statements follows:
Nature of Operations and Basis of Presentation
- ----------------------------------------------
Security Financial Corp. (the "Company") is a Delaware corporation organized
to become the holding company of the Security Dollar Bank (the "Bank"). The
Bank is a state-chartered commercial bank located in Ohio. The Company and
its subsidiary derive substantially all their income from banking and bank-
related services which include interest earnings on commercial, commercial
mortgage, residential real estate, and consumer loan financing as well as
interest on investment securities and a variety of deposit services to its
customers through six locations. The Company and the Bank are supervised by
the Federal Reserve Board, while the Bank is also subject to regulation and
supervision by the Ohio Division of Financial Institutions.
The consolidated financial statements of the Company include its wholly-owned
subsidiary, the Bank. Significant intercompany items have been eliminated in
consolidation.
The financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and revenues and expenses for the period. Actual results could differ
significantly from those estimates.
Investment Securities
- ---------------------
The Company has classified debt and equity securities as available for sale to
serve principally as a source of liquidity. Unrealized holding gains and
losses for available for sale securities are reported as a separate component
of stockholders' equity, net of tax, until realized. Realized securities
gains and losses are computed using the specific identification method.
Interest and dividends on investment securities are recognized as income when
earned. Premiums and discounts are recognized in interest income using a
method which approximates the interest method over the period to maturity.
Common stock of the Federal Home Loan Bank, Federal Reserve Bank, and
Independent State Bank of Ohio represent ownership in institutions which are
wholly-owned by other financial institutions. These securities are accounted
for at cost and are classified with equity securities available for sale.
Loans
- -----
Loans are reported at their principal amount net of the allowance for loan
losses. Interest on loans is recognized as income when earned on the accrual
method. The Company's general policy has been to stop accruing interest on
loans when it is determined that reasonable doubt exists as to the
collectibility of additional interest. Interest payments received on
nonaccrual loans is recorded as income or applied against principal according
to management's judgment as to the collectibility of the related loans.
Loan origination fees and certain direct loan origination costs are being
deferred and the net amount amortized as an adjustment of the related loan
yield. The Company is amortizing these amounts over the contractual lives of
the related loans.
19
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses
- -------------------------
The allowance for loan losses represents the amount which management estimates
is adequate to provide for potential losses in its loan portfolio. The
allowance method is used in providing for loan losses. Accordingly, all loan
losses are charged to the allowance and all recoveries are credited to it.
The allowance for loan losses is established through a provision for loan
losses charged to operations. The provision for loan losses is based on
management's periodic evaluation of individual loans, economic factors, past
loan loss experience, changes in the composition and volume of the portfolio,
and other relevant factors. The estimates used in determining the adequacy of
the allowance for loan losses, including the amounts and timing of future cash
flows expected on impaired loans, are particularly susceptible to changes in
the near term.
Impaired loans are commercial and commercial real estate loans for which it is
probable the Company will not be able to collect all amounts due according to
the contractual terms of the loan agreement. The Company individually
evaluates such loans for impairment and does not aggregate loans by major risk
classifications. The definition of "impaired loans" is not the same as the
definition of "nonaccrual loans," although the two categories overlap. The
Company may choose to place a loan on nonaccrual status due to payment
delinquency or uncertain collectibility, while not classifying the loan as
impaired if the loan is not a commercial or commercial real estate loan.
Factors considered by management in determining impairment include payment
status and collateral value. The amount of impairment for these types of
impaired loans is determined by the difference between the present value of
the expected cash flows related to the loan, using the original interest rate,
and its recorded value, or as a practical expedient in the case of
collateralized loans, the difference between the fair value of the collateral
and the recorded amount of the loans. When foreclosure is probable,
impairment is measured based on the fair value of the collateral.
Mortgage loans on one-to-four family properties and all consumer loans are
large groups of smaller balance homogeneous loans and are measured for
impairment collectively. Loans that experience insignificant payment delays,
which are defined as 90 days or less, generally are not classified as
impaired. Management determines the significance of payment delays on a case-
by-case basis taking into consideration all circumstances surrounding the loan
and the borrower including the length of the delay, the borrower's prior
payment record, and the amount of shortfall in relation to the principal and
interest owed.
Premises and Equipment
- ----------------------
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the estimated useful
lives of the assets. Expenditures for maintenance and repairs are charged
against income as incurred. Costs of major additions and improvements are
capitalized.
Intangible Asset
- ----------------
The intangible asset is comprised solely of a core deposit acquisition
premium. This core deposit acquisition premium, which was developed by a
specific core deposit life study, is amortized using the straight-line method
over the period to be benefited. Annual assessments of the carrying values
and remaining amortization periods of intangible assets are made to determine
possible carrying value impairment and appropriate adjustments as deemed
necessary. This asset is a component of other assets on the balance sheet.
Pension and Profit Sharing Plans
- --------------------------------
Pension and employee benefits include contributions, determined actuarially,
to a retirement plan covering eligible employees of the Bank. Contributions
to the profit sharing plan are made based on the achievement of certain
operating levels and performance ratios.
20
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Options
- -------------
The Company maintains a stock option plan for the directors, officers, and
employees. The stock options typically have expiration terms of ten years
subject to certain extensions and early terminations. The per share exercise
price of a stock option shall be, at a minimum, equal to the fair value of a
share of common stock on the date the option is granted. Because the exercise
price of the Company's stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized in the
Company's financial statements. If applicable, pro forma net income and
earnings per share would be presented to reflect the impact of the stock
option plan assuming compensation expense had been affected based on the fair
value of the stock options granted under this plan.
Income Taxes
- ------------
The Company and the Bank file a consolidated federal income tax return.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through
the provision for income taxes. Deferred income tax expenses or benefits are
based on the changes in the deferred tax asset or liability from period to
period.
Earnings Per Share
- ------------------
The Company provides dual presentation of Basic and Diluted earnings per
share. Basic earnings per share utilizes net income as reported as the
numerator and the actual average shares outstanding as the denominator.
Diluted earnings per share includes any dilutive effects of options, warrants,
and convertible securities.
Comprehensive Income
- --------------------
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." In adopting
Statement No. 130, the Company is required to present comprehensive income and
its components in a full set of general purpose financial statements for all
periods presented. The Company has elected to report the effects of Statement
No. 130 as part of the Statement of Changes in Stockholders' Equity.
Cash Flow Information
- ---------------------
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, federal funds sold, and interest-bearing deposits in other
banks with a maturity less than 90 days.
Cash payments for interest in 1998 and 1997 were $6,537,860 and $6,253,837,
respectively. Cash payments for income taxes for 1998 and 1997 were $140,000
and $482,000, respectively.
21
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Pending Accounting Pronouncements
- ---------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The Statement provides accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, by requiring the recognition of those items as
assets or liabilities in the consolidated balance sheet, recorded at fair
value. Statement No. 133 precludes a held-to-maturity security from being
designated as a hedged item; however, at the date of initial application of
this Statement, an entity is permitted to transfer any held-to-maturity
security into the available for sale or trading categories. The unrealized
holding gain or loss on such transferred securities shall be reported
consistent with the requirements of Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Such transfers do not raise an
issue regarding an entity's intent to hold other debt securities to maturity
in the future. This Statement applies prospectively for all fiscal quarters
of all years beginning after June 15, 1999. Earlier adoption is permitted for
any fiscal quarter that begins after the issue date of this Statement.
In March 1998, the Accounting Standards Executive Committee issued Statement
of Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." This SOP, which is effective for
fiscal years beginning after December 15, 1998, provides guidance on
accounting for the costs of computer software developed or obtained for
internal use and provides guidance for determining whether computer software
is for internal use. The Company will adopt SOP 98-1 in the first quarter of
1999 and does not believe the effect of adoption will be material.
Reclassification of Comparative Amounts
- ---------------------------------------
Certain comparative amounts for prior years have been reclassified to conform
with current year presentation. Such reclassifications had no effect on net
income.
At the 1997 Annual Stockholders meeting, stockholders approved the elimination
of the stated par on the Company's common stock. This act caused the capital
surplus amount to be reduced to zero, with the balance of $4,977,246 being
reclassified to the common stock amount.
2. EARNINGS PER SHARE
The following table sets forth the computation of Basic and Diluted earnings
per share. There were no convertible securities which would affect the
numerator in calculating Basic and Diluted earnings per share; therefore, net
income as presented on the Consolidated Statement of Income will be used as
the numerator. The following table sets forth a reconciliation of the
denominator of the Basic and Diluted earnings per share computation.
1998 1997
-------- --------
Denominator:
Denominator for Basic earnings per share-
weighted-average shares 344,669 328,989
Employee stock options 379 N/A
-------- --------
Denominator for Diluted earnings per
share - adjusted weighted-average
average assumed conversions 345,048 328,989
======== ========
22
<PAGE>
3. COMMON STOCK
Stock Dividend
- --------------
On December 14, 1998, the Company distributed 10,072 shares of common stock in
connection with a three percent stock dividend. As a result of the stock
dividend, common stock was increased by $722,000, and retained earnings was
decreased by $724,000. Fractional shares were paid in cash. All references
to per share amounts in the accompanying financial statements for 1997 have
been restated to reflect the stock dividend.
4. INVESTMENT SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated market values of investment securities
available for sale are as follows:
1998
---------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- -------- --------- -----------
U.S. Treasury and Government
agency securities $ 6,824,464 $ 15,258 $ (3,187) $ 6,836,535
Obligations of states and
political subdivisions 9,182,033 105,136 (59,101) 9,228,068
Mortgage-backed securities 26,499,393 339,260 (164,157) 26,674,496
----------- -------- --------- -----------
Total debt securities 42,505,890 459,654 (226,445) 42,739,099
Equity securities 1,468,638 158,793 (6,716) 1,620,715
----------- -------- --------- -----------
Total $43,974,528 $618,447 $(233,161) $44,359,814
=========== ======== ========= ===========
1997
---------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- -------- --------- -----------
U.S. Treasury and Government
agency securities $13,456,631 $ 30,215 $ (16,167) $13,470,679
Obligations of states and
political subdivisions 6,087,660 91,342 (12,734) 6,166,268
Mortgage-backed securities 20,770,857 132,780 (147,395) 20,756,242
Total debt securities 40,315,148 254,337 (176,296) 40,393,189
Equity securities 1,130,882 114,431 - 1,245,313
----------- -------- --------- -----------
Total $41,446,030 $368,768 $(176,296) $41,638,502
=========== ======== ========= ===========
Investment securities with carrying values of $22,615,602 and $20,532,070 at
December 31, 1998 and 1997, respectively, were pledged to secure public
deposits, securities sold under agreements to repurchase, and other purposes
as required by law.
23
<PAGE>
4. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued)
The amortized cost and estimated market values of debt securities at December
31, 1998, by contractual maturity, are shown below. The Company's mortgage-
backed securities have contractual maturities ranging from one to thirty
years. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
Estimated
Amortized Market
Cost Value
----------- -----------
Due in one year or less $ 624,824 $ 627,939
Due after one year through five years 7,491,580 7,509,833
Due after five years through ten years 4,243,888 4,220,404
Due after ten years 30,145,598 30,380,923
----------- -----------
Total $42,505,890 $42,739,099
=========== ===========
The following is a summary of proceeds received, gross gains, and gross losses
realized on the sale of investment securities:
1998 1997
----------- -----------
Proceeds from sales $ 4,365,457 $ 6,724,900
Gross gains 41,867 30,754
Gross losses - 5,504
5. LOANS
Major classifications of loans are summarized as follows:
1998 1997
----------- -----------
Real estate mortgages:
Residential $47,954,511 $46,686,796
Commercial 24,791,286 16,564,644
Commercial, financial, and
agricultural 10,255,062 13,398,099
Consumer loans 25,177,883 32,810,884
Other 2,576,186 2,968,271
----------- -----------
110,754,928 112,428,694
Less allowance for loan losses 1,802,773 1,677,651
----------- -----------
Net loans $108,952,155 $110,751,043
=========== ===========
At December 31, 1998 and 1997, the recorded investment in loans considered to
be impaired was $1,229,400 and $1,452,316, respectively, of which $933,675 and
$1,452,316, respectively, were on nonaccrual status at year end. The related
allowance for loan losses allocated to impaired loans was $238,000 and
$514,142 at December 31, 1998 and 1997, respectively. The average recorded
investment in impaired loans during the year was approximately $1,113,000 in
1998 and $995,000 in 1997. The Company recognized interest income on impaired
loans of $10,894 and $1,612 for the years ended December 31, 1998 and 1997,
respectively.
24
<PAGE>
5. LOANS (Continued)
The Company's primary business activity is with customers located within its
local trade area. Commercial, residential, and consumer loans are granted.
Although the Company has a diversified loan portfolio at December 31, 1998 and
1997, loans outstanding to individuals and businesses are dependent upon the
local economic conditions in its immediate trade area.
6. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
1998 1997
----------- -----------
Balance, January 1 $ 1,677,651 $ 1,678,528
Add:
Provisions charged to operations 2,267,000 1,250,000
Recoveries 112,173 85,744
Less loans charged off 2,254,051 1,336,621
Balance, December 31 $ 1,802,773 $ 1,677,651
7. PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as follows:
1998 1997
----------- -----------
Land $ 576,173 $ 246,173
Buildings 4,883,483 4,006,187
Furniture, fixtures, and equipment 3,321,227 3,119,571
----------- -----------
8,780,883 7,371,931
Less accumulated depreciation 3,813,044 3,538,606
----------- -----------
Total $ 4,967,839 $ 3,833,325
=========== ===========
Depreciation charged to operations was $313,186 in 1998 and $320,914 in 1997.
8. DEPOSITS
Time deposits include certificates of deposit in denominations of $100,000 or
more. Such deposits aggregated $13,487,912 and $15,723,898 at December 31,
1998 and 1997, respectively.
Maturities of time deposits of $100,000 or more are as follows at December 31:
1998
-----------
Three months or less $ 4,500,506
Three to twelve months 5,177,690
Over one year 3,809,716
-----------
$13,487,912
===========
25
<PAGE>
9. SHORT-TERM BORROWINGS
Short-term borrowings consists of securities sold under agreements to
repurchase and federal funds purchased. The outstanding balances and related
information for short-term borrowings are summarized as follows:
1998 1997
----------- -----------
Short-term borrowings:
Ending balance $ 7,649,027 $ 6,523,560
Maximum month-end balance
during the year 10,509,123 7,158,445
Average balance during the year 7,867,670 5,068,331
Average year end interest rate 3.47% 4.29%
Average interest rate during the year 4.05% 4.24%
Average amounts outstanding during the year represent daily averages. Average
interest rates represent interest expense divided by the related average
balances. The Company has pledged investment securities with carrying values
of $16,825,451 and $11,574,348 as of December 31, 1998 and 1997, respectively,
as collateral for the repurchase agreements.
The Bank maintains a credit arrangement with Federal Home Loan Bank of
Cincinnati, Ohio ("FHLB"). FHLB borrowings, when used, are collateralized by
the Bank's investment in Federal Home Loan Bank stock and a blanket collateral
pledge agreement with FHLB under which the Bank has pledged certain qualifying
assets equal to 150 percent of the unpaid amount of the outstanding balances.
At December 31, 1998, the Bank had a borrowing capacity of approximately $17.6
million with the FHLB. There were no such borrowings at December 31, 1998 or
1997.
At December 31, 1998 and 1997, the Company maintained unsecured lines of
credit with various financial institutions which totaled $15,000,000 and
$3,125,000, respectively. All lines were unused at December 31, 1998 and
1997, and are available to support general corporate purposes. There are no
fees to maintain these lines and no interest was paid.
10. OTHER EXPENSE
The following is an analysis of other expense:
1998 1997
----------- -----------
Stationery, printing, and supplies $ 158,648 $ 151,082
Professional fees 253,146 150,027
Data processing 125,958 117,933
Other 906,160 1,151,972
----------- -----------
Total $ 1,443,912 $ 1,571,014
=========== ===========
26
<PAGE>
11. INCOME TAXES
The provision for federal income taxes consist of:
1998 1997
----------- -----------
Currently payable $ (151,738) $ 570,752
Deferred tax 51,854 38,367
----------- -----------
Total provision $ (99,884) $ 609,119
=========== ===========
The components of the net deferred tax assets and liabilities are as follows:
1998 1997
----------- -----------
Deferred tax assets:
Allowance for loan losses $ 301,745 $ 396,753
Deferred compensation 11,895 15,373
Other 21,566 14,960
----------- -----------
Total 335,206 427,086
----------- -----------
Deferred tax liabilities:
Premises and equipment 53,021 44,625
Investment securities discount accretion 55,796 51,179
Loan origination fees, net 310,638 384,179
Net unrealized gain on securities 130,997 65,441
Other 65,147 44,645
----------- -----------
Total 615,599 590,069
----------- -----------
Net deferred tax liability $ (280,393) $ (162,983)
=========== ===========
The following is a reconciliation between the income tax expense and the
amounts of income taxes which would have been provided at statutory rates:
1998 1997
--------------------------------------------
% of % of
Pre-tax Pre-tax
Amount Income Amount Income
-------- -------- -------- --------
Provision at statutory
rate $ 17,995 34.0 % $655,373 34.0 %
Effect of tax-exempt
income (152,058) (287.3) (73,463) (3.8)
Nondeductible interest
expense 18,484 34.9 9,482 0.5
Other, net 15,695 29.7 17,727 0.9
-------- -------- -------- --------
Tax expense and
effective rates $(99,884) (188.7) % $609,119 31.6 %
======== ========= ======== ========
12. EMPLOYEE BENEFITS
The Company maintains a trusteed, Section 401(k) profit sharing plan with
contributions matching those by eligible employees to a maximum of 140 percent
of employee contributions annually, to a maximum of 5 percent of annual
salary. The Company may also provide for a discretionary profit sharing
contribution. All employees at least 20 1/2 years of age who have completed
one year of service are eligible to participate in the plan. The Company's
contribution to this plan was $96,990 in 1998 and $85,566 in 1997.
27
<PAGE>
13. DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The Company maintains a dividend reinvestment plan. Participation is
available to all common stockholders who are residents of the state of Ohio.
The plan provides each participant with a simple and convenient method of
purchasing additional common shares without payment of any brokerage
commission or other service fees.
A participant in the plan may elect to reinvest dividends on all or part of
their shares to acquire additional common stock. In addition, the plan
provides for the optional purchase of shares of the Company's common stock up
to a maximum of $4,000 per year. A participant may withdraw from the plan at
any time. Stockholders purchased 3,742 shares in 1998 and 3,737 shares in
1997 through the plan.
14. STOCK OPTION PLAN
In December 1997, the Board of Directors adopted a stock option plan for the
Directors, officers, and employees which was approved by stockholders at the
annual meeting on April 21, 1998. An aggregate of 20,000 shares of authorized
but unissued common stock of the Company were reserved for future issuance
under the plan. The stock options typically have expiration terms of ten
years subject to certain extensions and early terminations. The per share
exercise price of a stock option shall be, at a minimum, equal to the fair
value of a share of common stock on the date the option is granted.
On January 1, 1998 and June 25, 1998, qualified stock options were granted for
the purchase of 6,000 and 2,000 shares, respectively, exercisable at the
market price of $63.26 and $66.76 per share, respectively. The recipients of
the stock options vest over a three and five-year period. At December 31,
1998, none of the stock options were exercisable, and all initial stock
options granted remained outstanding.
The following table presents share data related to the outstanding options:
Weighted
Average
Exercise
1998 Price
---------- -----------
Outstanding, beginning - $ -
Granted 8,000 64.14
Exercised - -
Forfeited - -
----------
Outstanding, ending 8,000 $ 64.14
==========
28
<PAGE>
15. COMMITMENTS AND CONTINGENT LIABILITIES
Commitments
In the normal course of business, there are various outstanding commitments
and contingent liabilities not reflected in the accompanying consolidated
financial statements. Commitments to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in
the contract. Standby letters of credit are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party.
These commitments were comprised of the following:
1998 1997
----------- -----------
Commitments to extend credit $17,098,019 $11,792,000
Standby letters of credit and
financial guarantees 837,102 830,000
----------- -----------
Total $17,935,121 $12,622,000
=========== ===========
The instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the consolidated balance
sheet. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments.
Generally, collateral is not required to support financial instruments with
credit risk. The terms are typically for a one-year period with an annual
renewal option subject to prior approval by management.
Contingent Liabilities
- ----------------------
The Company and Bank are involved in various legal actions from normal
business activities. Management believes the liability, if any, arising from
such litigation will not have a material adverse effect on the Company's
financial position.
16. REGULATORY MATTERS
Federal law prevents Security Financial Corp. from borrowing from the Bank
unless the loans are secured by specific collateral. Further, such secured
loans are limited in amount to ten percent of the Bank's capital.
The Bank is subject to legal limitations on the amount of dividends it can pay
as a state-chartered member of the Federal Reserve Bank System. Prior
approval of the Federal Reserve Board is required if the total of all
dividends declared by the Bank in any calendar year exceeds net profits, as
defined for the year, combined with its retained net profits for the two
preceding calendar years less any required transfers to surplus. Using this
formula, the amount available for payment of dividends by the Bank to the
Company in 1998, without approval of the Federal Reserve Board, will be
limited to $1,279,988 plus 1999 net profits retained up to the date of the
dividend declaration.
The district Federal Reserve Bank requires the Bank to maintain certain
average reserve balances. As of December 31, 1998 and 1997, the Bank had
required reserves of $716,000 and $715,000, respectively, comprised of vault
cash and a depository amount held with the Federal Reserve Bank.
29
<PAGE>
17. REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal regulatory agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by the regulators that, if undertaken, could
have a direct material effect on an entity's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of the entities' assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company'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 the regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of
Total and Tier I capital (as defined in the regulations) to Risk-weighted
assets (as defined) and of Tier I capital to average assets (as defined).
Management believes as of December 31, 1998 and 1997, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 1998, the most recent notification from the appropriate
primary regulator has categorized the Company and Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, an entity must maintain minimum Total Risk-
based, Tier I Risk-based, and Tier I Leverage ratios at least 100 to 200 basis
points above those ratios set forth in the table. There have been no
conditions or events since that notification that management believes have
changed the Company's or the Bank's category.
The consolidated capital position of the Company does not materially differ
from the Bank's; therefore, the following table sets forth the Company's
capital position and minimum requirements as of December 31:
1998 1997
-------------------- -------------------
Amount Ratio Amount Ratio
---------- -------- ----------- ------
Total Capital
(to Risk-weighted Assets)
- -------------------------
Actual $ 15,252,770 14.25% $ 15,245,699 13.72%
For Capital Adequacy 8,563,447 4.00% 8,888,669 4.00%
To Be Well Capitalized 10,704,308 6.00% 11,110,837 6.00%
Tier 1 Capital
(to Risk-weighted Assets)
- -------------------------
Actual $ 13,908,994 12.99% $ 13,853,279 12.47%
For Capital Adequacy 4,281,723 4.00% 4,444,335 4.00%
To Be Well Capitalized 6,422,585 6.00% 6,666,502 6.00%
Tier 1 Capital (to
Average Assets)
- ------------------
Actual $ 13,908,994 8.12% $ 13,853,279 8.52%
For Capital Adequacy 6,855,763 4.00% 6,500,588 4.00%
To Be Well Capitalized 8,569,704 5.00% 8,125,735 5.00%
30
<PAGE>
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------- -----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
Financial assets: ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cash and due from banks,
interest- bearing deposits
in other banks, and federal
funds sold $ 11,131,009 $ 11,131,009 $ 8,906,457 $ 8,906,457
Investment securities available
for sale 44,359,814 44,359,814 41,638,502 41,638,502
Net loans 108,952,155 109,797,000 110,751,043 115,808,789
Accrued interest receivable 1,069,321 1,069,321 1,041,992 1,041,992
----------- ----------- ----------- -----------
Total $165,512,299 $166,357,144 $162,337,994 $167,395,740
=========== =========== =========== ===========
Financial liabilities:
Deposits $148,916,886 $149,031,289 $145,352,461 $146,340,299
Short-term borrowings 7,649,027 7,649,027 6,523,560 6,523,560
Accrued interest payable 292,850 292,850 338,699 338,699
----------- ----------- ----------- -----------
Total $156,858,763 $156,973,166 $152,214,720 $153,202,558
=========== =========== =========== ===========
</TABLE>
Financial instruments are defined as cash, evidence of an ownership interest
in an entity, or a contract which creates an obligation or right to receive or
deliver cash or another financial instrument from/to a second entity on
potentially favorable or unfavorable terms.
Fair value is defined as the amount at which a financial instrument could be
exchanged in a current transaction between willing parties other than in a
forced liquidation sale. If a quoted market price is available for a
financial instrument, the estimated fair value would be calculated based upon
the market price per trading unit of the instrument.
If no readily available market exists, the fair value estimates for financial
instruments should be based upon management's judgment regarding current
economic conditions, interest rate risk, expected cash flows, future estimated
losses, and other factors as determined through various option pricing
formulas or simulation modeling. As many of these assumptions result from
judgments made by management based upon estimates which are inherently
uncertain, the resulting estimated fair values may not be indicative of the
amount realizable in the sale of a particular financial instrument. In
addition, changes in the assumptions on which the estimated fair values are
based may have a significant impact on the resulting estimated fair values.
As certain assets and liabilities such as lease receivables, deferred tax
assets, and premises and equipment are not considered financial instruments,
the estimated fair value of financial instruments would not represent the full
value of the Company.
The Company employed simulation modeling in determining the estimated fair
value of financial instruments for which quoted market prices were not
available based upon the following assumptions:
Cash and Due From Banks, Interest-bearing Deposit in Other Banks, Federal
- -------------------------------------------------------------------------
Funds Sold, Accrued Interest Receivable, Short-term Borrowings, and Accrued
- ---------------------------------------------------------------------------
Interest Payable
- ----------------
The fair value is equal to the current carrying value.
31
<PAGE>
18. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Investment Securities Available for Sale
- ----------------------------------------
The fair value of investment securities available for sale is equal to the
available quoted market price. If no quoted market price is available, fair
value is estimated using the quoted market price for similar securities.
Loans and Deposits
- ------------------
The fair value of loans is estimated by discounting the future cash flows
using a simulation model which estimates future cash flows and employs
discount rates that consider reinvestment opportunities, operating expenses,
non-interest income, credit quality, and prepayment risk. Demand, savings,
and money market deposit accounts are valued at the amount payable on demand
as of year end. Fair value for time deposits are estimated using a discounted
cash flow calculation that applies contractual cost currently being offered in
the existing portfolio to current market rates being offered for deposits of
similar remaining maturities.
Commitments to Extend Credit and Standby Letters of Credit
- ----------------------------------------------------------
These financial instruments are generally not subject to sale, and estimated
fair values are not readily available. The carrying value, represented by the
net deferred fee arising from the unrecognized commitment or letter of credit,
and the fair value, determined by discounting the remaining contractual fee
over the term of the commitment using fees currently charged to enter into
similar agreements with similar credit risk, are not considered material for
disclosure. The contractual amounts of unfunded commitments and letters of
credit are presented in the Commitments and Contingent Liabilities note.
19. PARENT COMPANY
Following are condensed parent-only financial statements for Security
Financial Corp.
CONDENSED BALANCE SHEET
1998 1997
----------- -----------
ASSETS
Cash on deposit in subsidiary bank $ 347,711 $ 617,087
Interest-bearing deposit in other banks 100,000 100,000
Investment in subsidiary bank 13,874,166 13,695,496
Investment securities available for sale 463,365 248,462
Other assets 10,744 10,744
----------- -----------
TOTAL ASSETS $ 14,795,986 $ 14,671,789
=========== ===========
LIABILITIES $ 51,706 $ 38,906
STOCKHOLDERS' EQUITY 14,744,280 14,632,883
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 14,795,986 $ 14,671,789
=========== ===========
32
<PAGE>
19. PARENT COMPANY (Continued)
CONDENSED STATEMENT OF INCOME
Year Ended December 31,
1998 1997
------------ ------------
INCOME
Dividends from subsidiary bank $ 125,000 $ 125,000
Dividend income 13,754 7,481
------------ ------------
Total income 138,754 132,481
EXPENSES
Operating expense 62,205 17,762
------------ ------------
Income before equity in undistributed
earnings of subsidiary 76,549 114,719
Equity in undistributed
earnings of subsidiary 76,259 1,203,729
------------ ------------
NET INCOME $ 152,808 $ 1,318,448
============ ============
CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31,
1998 1997
------------ ------------
OPERATING ACTIVITIES
Net income $ 152,808 $ 1,318,448
Adjustments to reconcile
net income to net cash provided
by operating activities:
Equity in undistributed earnings
of subsidiary (76,259) (1,203,729)
------------ ------------
Net cash provided by
operating activities 76,549 114,719
------------ ------------
INVESTING ACTIVITY
Increase in interest-bearing
deposits in other banks - (100,000)
Purchase of investment securities
available for sale (177,259) -
Investment in subsidiary - (2,000,000)
------------ ------------
Net cash used for
investing activities (177,259) (2,100,000)
------------ ------------
FINANCING ACTIVITIES
Proceeds from sale of
common stock - 2,581,682
Proceeds from dividend
reinvestment and stock purchase plan (262,156 223,268
Dividends paid on common stock (430,822) (376,307)
------------ ------------
Net cash provided by
(used for) financing activities (168,666) 2,428,643
------------ ------------
Increase (decrease) in cash (269,376) 443,362
CASH AT BEGINNING OF YEAR 617,087 173,725
------------ ------------
CASH AT END OF YEAR $ 347,711 $ 617,087
============ ============
33
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1998
<CASH> 8,056
<INT-BEARING-DEPOSITS> 1,294
<FED-FUNDS-SOLD> 1,781
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 44,360
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 110,755
<ALLOWANCE> 1,803
<TOTAL-ASSETS> 172,074
<DEPOSITS> 148,917
<SHORT-TERM> 7,649
<LIABILITIES-OTHER> 764
<LONG-TERM> 0
0
0
<COMMON> 6,794
<OTHER-SE> 7,950
<TOTAL-LIABILITIES-AND-EQUITY> 172,074
<INTEREST-LOAN> 9,856
<INTEREST-INVEST> 2,537
<INTEREST-OTHER> 264
<INTEREST-TOTAL> 12,657
<INTEREST-DEPOSIT> 6,174
<INTEREST-EXPENSE> 6,492
<INTEREST-INCOME-NET> 6,165
<LOAN-LOSSES> 2,267
<SECURITIES-GAINS> 51
<EXPENSE-OTHER> 4,730
<INCOME-PRETAX> 53
<INCOME-PRE-EXTRAORDINARY> 53
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 153
<EPS-PRIMARY> .44
<EPS-DILUTED> .44
<YIELD-ACTUAL> 4.08
<LOANS-NON> 1,300
<LOANS-PAST> 331
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,000
<ALLOWANCE-OPEN> 1,678
<CHARGE-OFFS> 2,254
<RECOVERIES> 112
<ALLOWANCE-CLOSE> 1,803
<ALLOWANCE-DOMESTIC> 1,803
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
