UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the quarterly period ended March 31, 1999 or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from _______to_________
.
Commission file number 0-27590
SECURITY BANK HOLDING COMPANY
(Exact name of issuer as specified in its charter)
Oregon 93-0800253
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
170 S. Second St., Coos Bay, Oregon 97420
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(Address of Principal Executive Offices) (Zip Code)
(541) 267-5356
--------------
(Issuer's telephone number)
Check whether the issuer (1)filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
---- ----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Class Outstanding at April 30, 1999
Common Stock, $5.00 par value 4,458,263
<PAGE>
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Form 10-Q Table of Contents
Part I
Item 1. Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Part II
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on form 8-K
Signatures
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS Mar. 31, 1999 Dec. 31, 1998
------------- -------------
(Unaudited)
Cash and cash equivalents:
Cash and due from banks $ 9,258 $ 10,686
Federal funds sold 18,347 7,667
-------- --------
Total cash and cash equivalents 27,605 18,353
Investment securities available for sale 78,044 87,575
Loans, net 145,304 142,209
Mortgage loans held for sale, at cost which
approximates market 4,254 5,920
Net investment in direct financing leases 2,578 2,813
Premises and equipment, net 11,080 10,518
Federal Home Loan Bank stock, at cost 2,063 2,007
Federal Reserve Bank stock, at cost 649 649
Other assets 4,690 3,595
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Total assets $276,267 $273,639
======== ========
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand $ 39,458 $ 40,539
NOW accounts 34,282 35,777
Money market accounts 44,283 40,883
Savings accounts 22,200 21,341
Time deposit 93,211 88,255
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Total deposits 233,434 226,795
Securities sold under agreements to repurchase 7,573 10,388
Short term borrowings 118 32
Other borrowings 800 --
Other liabilities 3,632 5,168
-------- --------
Total liabilities 245,557 242,383
-------- --------
Minority interest in subsidiary 2,219 2,224
Shareholders' equity:
Nonvoting preferred stock, $5 par value
Authorized 5,000,000 shares; none issued -- --
Voting preferred stock, $5 par value
Authorized 5,000,000 shares; none issued -- --
Common stock, $5 par value
Authorized 10,000,000 shares - issued and outstanding
4,458,183 shares in 1999 (4,451,196 shares in 1998) 22,291 22,256
Surplus 3,899 3,863
Retained earnings 2,167 2,454
Accumulated other comprehensive income 134 459
-------- --------
Total shareholders' equity 28,491 29,032
-------- --------
Total liabilities, minority interest and shareholders'
equity $276,267 $273,639
======== ========
See accompanying notes to consolidated financial statements
<PAGE>
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED-DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Three months ended March 31,
1999 1998
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Interest income:
Interest on loans $3,372 $3,294
Interest and dividends on securities:
Taxable 918 1,101
Exempt from Federal income tax 192 187
Dividend income on Federal Home Loan Bank stock 39 39
Dividend income on Federal Reserve Bank stock 10 --
Interest on Federal funds sold 150 226
Income on direct financing leases 63 70
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Total interest income 4,744 4,917
Interest expense:
Deposits
NOW 119 114
Money market 377 313
Savings 122 117
Time 1,143 1,155
Securities sold under agreements to repurchase 92 83
Short term borrowings 3 6
Federal Home Loan Bank borrowings -- 223
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Total interest expense 1,856 2,011
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Net interest income 2,888 2,906
Provision for loan losses 104 61
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Net interest income after provision for loan losses 2,784 2,845
Other income:
Service charges on deposit accounts 312 281
Gain on sale/call of investments available for sale, net 184 2
Loan servicing fees 77 61
Sold real estate loan fees 631 609
Other 196 180
----- ---
Total other income 1,400 1,133
Other expense:
Salaries and employee benefits 1,971 1,746
Occupancy of bank premises 207 191
Furniture and equipment 227 235
Professional fees 175 214
FDIC assessment 7 8
Supplies 135 90
ESOP compensation -- 168
Other 560 532
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Total other expense 3,282 3,184
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Income before provision for income taxes 902 794
Provision for income taxes 302 284
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Net income before minority interest 600 510
Net (income) loss attributable to minority interest 5 (9)
---- ----
Net income $605 $501
==== ====
Net income per share - Basic $.14 $.12
==== ====
Net income per share - Diluted $.14 $.12
==== ====
See accompanying notes to consolidated financial statements
<PAGE>
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED-DOLLARS IN THOUSANDS)
Three months ended March 31,
1999 1998
---- ----
Net Income $605 $501
Other comprehensive income, net of income tax:
Unrealized loss on investment securities (325) (30)
---- ----
Comprehensive income $280 $471
==== ====
See accompanying notes to consolidated financial statements
<PAGE>
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Accumulated
Common Stock Unearned Other Total
Retained ESOP Shares Comprehensive Shareholders'
Shares Amount Surplus Earnings At Cost Income Equity
------ ------ ------- -------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, Dec. 31, 1997 4,442,097 $22,210 $1,596 $5,629 $(1,469) $457 $28,423
Net loss -- -- -- (1,549) -- -- (1,549)
Dividends -- -- -- (1,626) -- -- (1,626)
Sale of common stock 3,579 18 (1) -- -- -- 17
Stock options exercised 5,520 28 3 -- -- -- 31
Release of ESOP shares -- -- 2,265 -- 1,469 -- 3,734
Unrealized gain on securities
available for sale -- -- -- -- -- 2 2
---------------------------------------------------------------------------
Balance, Dec. 31, 1998 4,451,196 $22,256 $3,863 $2,454 $-- $459 $29,032
(UNAUDITED)
Net income -- -- -- 605 -- -- 605
Dividends -- -- -- (892) -- -- (892)
Sale of common stock 6,987 35 36 -- -- -- 71
Unrealized loss on securities
available for sale -- -- -- -- -- (325) (325)
---------------------------------------------------------------------------
Balance, March 31, 1999 4,458,183 $22,291 $3,899 $2,167 $-- $134 $28,491
===========================================================================
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED-DOLLARS IN THOUSANDS)
Three months ended March 31,
1999 1998
---- ----
Cash flows provided by operating activities:
Net income $605 $501
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 265 206
Deferred taxes related to
available for sale securities 207 19
Provision for loan losses 104 61
Origination of mortgage loans held for sale (30,230) (30,490)
Proceeds from mortgage loans sold 31,896 29,626
Net gain on call of investment securities
available for sale (184) (2)
Federal Home Loan Bank stock dividend (38) (35)
ESOP related compensation expense -- 227
(Increase) decrease in other assets (1,095) 93
(Decrease) increase in other liabilities (1,536) 707
Minority interest in subsidiary (5) 9
---- ----
Net cash (used in) provided by
operating activities (11) 922
Cash flows from investing activities:
Purchase of investment securities
available for sale (16,428) (5,833)
Proceeds from sale of securities
available for sale 17,470 --
Proceeds from maturities and call of investment
securities available for sale 8,029 12,297
Net loan originations (repayments) (635) 975
Purchase of participations (2,564) --
Additions to premises and equipment (715) (834)
Purchase of Federal Home Loan Bank stock (18) (21)
Originations of direct financing leases (94) (165)
Gross payments on direct financing leases 329 264
----- -----
Net cash provided by investing activities 5,374 6,683
Cash flows from financing activities:
Net increase in deposits 6,639 1,781
Decrease in securities sold with agreements to
repurchase (2,815) (711)
Decrease of Federal Home Loan Bank borrowings -- (2,000)
Increase in other borrowings 800 --
Proceeds from issuance of common stock 71 41
Payment of dividends (892) (812)
(Decrease) increase in short term borrowings 86 (297)
------ ------
Net cash provided by (used in) financing activities 3,889 (1,998)
Net increase in cash and cash equivalents 9,252 5,607
Cash and cash equivalents at beginning of period 18,353 29,252
------ ------
Cash and cash equivalents at end of period $ 27,605 $ 34,859
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $1,839 $2,011
Income taxes $22 $58
Supplemental disclosures of investing activities:
Unrealized loss on investment
securities available for sale, net of tax $(325) (30)
Loans transferred to other real estate owned $-- $--
See accompanying notes to consolidated financial statements
<PAGE>
SECURITY BANK HOLDING COMPANY & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Basis of Financial Statement Presentation
-----------------------------------------
The interim consolidated financial statements include the accounts of Security
Bank Holding Company (the Company), a bank holding company, its wholly-owned
subsidiaries, Security Bank, Pacific State Bank (Pacific State) and Family
Security Bank (Family Security), its majority-owned subsidiaries, Lincoln
Security Bank (Lincoln Security) and McKenzie State Bank (McKenzie State), and
Security Bank's wholly-owned subsidiary, Alland, Inc.. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The interim consolidated financial statements are not audited, but include all
adjustments that the Company considers necessary for a fair presentation of the
results of operations for such interim periods. In preparing the consolidated
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 sheets and income and expenses for the periods. Actual results could
differ from those estimates. The balance sheet data as of December 31, 1998 was
derived from audited financial statements, but does not include all disclosures
contained in the Company's 1998 Annual Report to Shareholders. The interim
consolidated financial statements should be read in conjunction with the
December 31, 1998 consolidated financial statements, including the notes
thereto, included in the Company's 1998 Annual Report to Shareholders. Certain
amounts for 1998 have been reclassified to conform with the 1999 presentation.
The results of operations for the interim period shown in this report are not
necessarily indicative of results for any future interim period or the entire
fiscal year.
(2) Earnings Per Share
------------------
Basic and diluted earnings per share are based on the weighted average number of
common shares outstanding during each period, with diluted including the effect
of potentially dilutive common shares. For the three months ended March 31, 1998
the weighted average number of common shares outstanding did not include 384,784
shares held by the Company's ESOP as these shares had not been allocated to
participant accounts, nor had they been committed to be released. The weighted
average number of common shares outstanding for basic earnings per share
computations were 4,451,209 and 4,060,135 at March 31, 1999 and 1998,
respectively. For diluted earnings per share, 25,791 and 44,004 were added to
weighted average shares outstanding for 1999 and 1998, respectively,
representing potential dilution for stock options outstanding, calculated using
the treasury stock method.
(3) Other Borrowings
----------------
At March 31, 1999 the Company had $800,000 in borrowings from a third party
bank. The one year, $1,000,000 Draw Note Line of Credit was secured to complete
the capitalization of Oregon State Bank, which commenced operations on April 1,
1999. The Draw Note Line of Credit is a variable rate note based on prime, which
was 7.75% at March 31, 1999.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
For the Quarter ended March 31, 1999 and 1998
GENERAL. Net income increased to $605,000 for the three months ended March 31,
1999 from $501,000 for the same period in 1998, a 21% increase. The increase in
net income is mostly attributable to increases in other income due to gains on
the sale of investment securities available for sale and an increase in service
charge income on deposit accounts due to an increase in average deposits,
coupled with no ESOP compensation expense in 1999 as the Company deleveraged the
ESOP in December 1998.
NET INTEREST INCOME. Net interest income is the difference between interest
income (principally from loans and investment securities) and interest expense
(principally on customer deposits and borrowings). Changes in net interest
income result from changes in volume, net interest spread, and net interest
margin. Volume refers to the average dollar level of interest earning assets and
interest bearing liabilities. Net interest spread refers to the differences
between the average yield on interest earning assets and the average cost of
interest bearing liabilities. Net interest margin refers to net interest income
divided by average interest earning assets. The Company's profitability, like
that of many financial institutions, is dependent to a large extent upon net
interest income. Since the Company tends to be asset sensitive, as interest
earning assets mature or reprice more quickly than interest bearing liabilities
in a given period, a significant decrease in the market rates of interest could
adversely affect net interest income. In contrast, an increasing interest rate
environment could favorably impact net interest income. Competition and the
economy also impact the Company's net interest income.
Net interest income before the provision for loan losses decreased $18,000 or
.62% for the three months ended March 31, 1999 over the same period in 1998. Of
the net decrease of $18,000, an increase in volume accounted for an increase in
net interest income of $42,000, while a decrease in spread accounted for a
decrease in net interest income of $60,000. Average interest earning assets
increased $4.5 million, while average interest bearing liabilities increased
$5.9 million. The increase in average interest earning assets and interest
bearing liabilities resulted from an increase in deposits, offset by a decrease
in average borrowings from the Federal Home Loan Bank of $14.6 million.
The average net interest spread decreased from 4.61% to 4.54%, mainly due to
decreased average earning asset yields which declined 43 basis points from 8.12%
to 7.69%. The low/flat interest rate yield curve has caused variable rate
repricing on assets over the period decreasing asset yields. In addition,
certain fixed rate loans and investments have refinanced/repriced at the lower
rates over the period. Average rates paid decreased 35 basis points to 3.16% in
the first quarter of 1999 from 3.51% in the first quarter of 1998, primarily
from a reduction in deposit cost, and the repayment of all Federal Home Loan
Bank advances in December 1998. The Company's net interest margin for the first
quarter of 1999 was 4.68%, a decrease of 12 basis points from 4.80% for the
first quarter of 1998.
PROVISION FOR LOAN LOSSES. The loan loss provision during the three-month period
ended March 31, 1999, was $104,000 and $61,000 for the same period in 1998. The
increase is primarily due to maintaining the reserve balance at 1.5% of total
loans at March 31, 1999 as compared to 1% at March 31, 1998. The increase in the
reserve ratio to 1.5% in December 1998 was in response to regulatory
recommendations, which did not address specific loans within the Bank's
portfolio, but rather recommended the reserve be increased to more closely match
the Company's peer group. The loss reserve ratio for the Company's peer group
ranges from 1.2% to 1.5%. Net charge-offs during the three month periods were
$29,000 and $45,000 for 1999 and 1998, respectively.
Management believes the loan loss provision maintains the reserve for loan
losses at an appropriate level. The reserve for loan losses was $2,369,000 at
March 31, 1999, as compared to $1,445,000 at March 31, 1998.
Non-performing assets (defined as loans on non-accrual status, 90 days or more
past due, and other real estate owned) were $796,000 and $1,085,000 at March 31,
1999 and 1998, respectively. Management believes the loans are adequately
secured and that no significant losses will be incurred.
<PAGE>
OTHER INCOME. Other income increased 24% to $1,400,000 for the three months
ended March 31, 1999 as compared to $1,133,000 for the same period in 1998. The
increase in other income is due to gains on the sale of investment securities
available for sale and an increase in service charge income on deposit accounts
due to an increase in average deposits. The Company utilized overnight
borrowings at December 31, 1998 to pay-off longer term Federal Home Loan Bank
advances in December 1998. In January 1999, facing the possibility of a rising
interest rate environment, the Company sold approximately $8 million in
investments available for sale to repay the overnight borrowings.
OTHER EXPENSE. Other expense (including ESOP Compensation expense as discussed
below) increased 3% to $3,282,000 for the three months ended March 31, 1999
compared to $3,184,000 for the same period in 1998. Salaries and employee
benefits, the largest non interest expense, increased 12.9%. The increase in
salaries is primarily due to the addition of McKenzie State Bank in November
1998, and of staff to support the growth with the new banks. Additional
increases were experienced in other expense resulting from the Company's overall
growth strategy.
ESOP COMPENSATION EXPENSE. The Company sponsors an Employee Stock Ownership Plan
(ESOP), a leveraged employee-retirement benefit plan which owns approximately
22% of the common stock of the Company. In 1998, the ESOP debt was repaid in
full, thereby releasing all remaining shares for allocation and reducing ESOP
compensation expense to zero for 1999.
FINANCIAL CONDITION
Total assets have remained relatively constant from December 31, 1998,
increasing $2,628,000 to $276.3 million at March 31, 1999.
Net loans and leases increased in the period from $150.9 million at December 31,
1998 to $152.1 million at March 31, 1999. The increase is due to the growth
strategy of the Company and the addition of the new banks, McKenzie State Bank
and Oregon State Bank. McKenzie State Bank's net loans increased $1.6 million to
$3.2 million at March 31, 1999 compared to $1.6 million at December 31, 1998.
The low interest rate environment has resulted in increased calls on callable
agency investment securities, and has accelerated repayments on mortgage backed
investment securities. Due to the flat yield curve, the Company has taken a
defensive posture and retained the majority of these funds in Federal funds
sold. At the time a more typical positive slope to the yield curve occurs, the
Company will increase the maturities. Until that time, the Company does not
believe extending maturities is adequately rewarding.
The increase in premises and equipment during the first quarter of 1999 results
from expansion activities underway by the Company. Additions represent costs
incurred at McKenzie State Bank and for the construction of the new main branch
of Security Bank in Coos Bay, Oregon.
Deposit growth has continued for the first quarter of 1999, increasing $6.6
million to $233.4 million at March 31, 1999, compared to $226.8 million at
December 31, 1998. The growth in 1999 has been predominantly in money market and
time deposits.
Securities sold under agreements to repurchase decreased $2.8 million to $7.6
million at March 31, 1999, compared to $10.4 million at December 31, 1998. The
decrease is related to the payoff of Federal Home Loan Bank (FHLB) borrowings in
1998. As these securities were no longer required as collateral for FHLB
borrowings, the securities were sold to reduce Federal Funds Purchased.
Other borrowings increased to $800,000 at March 31, 1999. The increase is due to
borrowings from a third party bank to complete the capitalization of Oregon
State Bank, which commenced operations April 1, 1999.
LIQUIDITY
Liquidity enables the Company to meet the withdrawals of its depositors and the
borrowing needs of its loan customers. The Company maintains its liquidity
position through maintenance of cash resources and a stable core deposit base. A
further source of liquidity is the Company's ability to borrow funds. The
Company maintains three unsecured lines of credit totaling $11.0 million for the
purchase of funds on an overnight basis. The Company is also a member of the
Federal Home loan Bank which provides a secured line of credit in the amount of
$55.4 million, and other funding opportunities for liquidity and asset/liability
matching. Over the past four years these lines have been used periodically. As
of March 31, 1999 no funds were borrowed under the Company's unsecured lines of
<PAGE>
credit and no funds were borrowed from the Federal Home Loan Bank. Interest
rates charged on the lines are determined by market factors. The Company's
liquidity has been stable and adequate over the past several years. Short-term
deposits have continued to grow and excess investable cash is invested on a
short-term basis into Federal funds sold. The Company's primary source of funds
is consumer deposits and commercial accounts. These funds are not subject to
significant movements as a result of changing interest rates and other economic
factors, and therefore enhance the Company's long term liquidity.
CAPITAL RESOURCES
Beginning in 1990, federal regulators required the calculation of Risk-based
Capital. This is an analysis that weights balance sheet and off-balance sheet
items for their inherent risk. It requires minimum standards for Risk-based
Capital by Capital Tier. Full implementation of this analysis was required in
1992, requiring a minimum total Risk-based Capital ratio of 8.00%, a minimum
Tier 1 Capital Ratio of 4.00% and a minimum Leverage Capital Ratio of 4.00%.
At March 31, 1999, the Company's estimated regulatory capital ratios were as
follows: Total Risk-based Capital Ratio of 17.34%, Tier 1 Capital Ratio of
16.10% and Leverage Capital Ratio of 10.82%. This was compared to 17.15%, 15.94%
and 10.72% for total Risk-based Capital Ratio, Tier 1 Capital Ratio and Leverage
Capital Ratio, respectively, at December 31, 1998. If the Company were fully
leveraged, further growth would be restricted to the level attainable through
generation and retention of net income unless the Company were to seek
additional capital from outside sources.
YEAR 2000 ISSUES
INTRODUCTION. The Year 2000 creates challenges with respect to the automated
systems used by financial institutions and other companies. Many software
programs are not able to recognize the year 2000, since most programs and
systems were designed to store calendar years in the 1900's by assuming the "19"
and storing only the last two digits of the year. For example, these automated
systems would recognize a year stored as "00" as the year "1900", rather than as
the year "2000". If these automated systems are not appropriately re-coded,
updated or replaced before the year 2000, they will likely confuse data, crash
or fail in some manner. In addition, many software programs and automated
systems will fail to recognize the year 2000 as a leap year. The problem is not
limited to computer systems. Year 2000 issues will potentially affect every
system that has an embedded microchip, such as automated teller machines,
elevators and vaults.
The year 2000 challenge is especially problematic for financial institutions,
since many transactions such as interest accruals and payments are date
sensitive. It also may affect the operations of third parties with whom the
Company does business, including the Company's vendors, suppliers, utility
companies and customers.
THE COMPANY'S STATE OF READINESS. The Company is committed to addressing
these year 2000 challenges in a prompt and responsible manner and has dedicated
resources to do so. Management has completed an assessment of its automated
systems and has implemented a plan to resolve these issues, including purchasing
appropriate computer technology. The Company's year 2000 compliance plan ("Y2K
Plan") has five phases. These phases are (1) project management, (2) awareness,
(3) assessment, (4) testing, and (5) renovation and implementation. The Company
has substantially completed phases one through four, although appropriate
follow-up activities are continuing to occur, and the Company is currently
involved in the renovation and implementation phase of the Y2K Plan.
Project Management. The Company has assigned primary responsibility for year
2000 project management to its Vice President-Data Processing. The Company has
also formed a year 2000 compliance committee, consisting of appropriate
representatives from its critical operational areas including each of the
affiliate banks, to assist the Vice President-Data Processing in implementing
the Y2K Plan. In addition, the Company provides monthly reports to its Board of
Directors and to the Boards of Directors of each of its subsidiaries in order to
assist them in overseeing the Company's year 2000 readiness.
Awareness. The Company has completed several projects designed to promote
awareness of year 2000 issues throughout our organization and our customer base.
These projects include communication through local seminars in each of the
communities the Company serves, mailing information brochures to deposit and
loan customers, providing training for lending officers and other staff, and
responding to vendor, customer, and shareholder inquiries.
<PAGE>
Assessment. Assessment is the process of identifying all mission-critical
applications that could potentially be negatively affected by dates in the year
2000 and beyond. The Company's assessment phase is substantially complete.
Systems examined during this phase included telecommunications systems,
account-processing applications, and other software and hardware used in
connection with customer accounts. The Company's operations, like those of many
other companies, are intertwined with the operations of certain of its business
partners. Accordingly, the Company's operations could be materially affected if
the operations of those companies who provide the Company with mission critical
applications, systems, and services are materially affected. For example, the
Company depends upon vendors who provide equipment, technology, and software to
it in connection with its business operations. Failure of these software vendors
to achieve year 2000 readiness could substantially affect the operations of the
Company. In addition, lawsuits and other financial challenges materially
affecting the financial viability of these vendors could materially affect the
Company. In response to this concern, the Company has identified and contacted
those vendors who provide our mission-critical applications. The Company has
assessed their year 2000 compliance efforts and will continue to monitor their
progress as the year 2000 approaches.
Testing. Updating and testing of the Company's mission-critical automated
systems has been completed. All mission-critical systems were successfully
tested to verify that dates in the year 2000 are being appropriately recognized
and processed. Testing of renovations and new systems will continue throughout
1999.
Renovation and Implementation. This phase involves obtaining and implementing
renovated software applications provided by our vendors. As these applications
are received and implemented, the Company will test them for year 2000
compliance. This phase also involves upgrading and replacing automated systems
where appropriate and will continue throughout 1999. Although this phase will be
substantially complete before the end of 1999, additional follow-up activities
may take place in the year 2000 and beyond.
ESTIMATED COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES. The total financial
effect of these year 2000 challenges on the Company cannot be predicted with
certainty at this time. In fact, in spite of all efforts being made to rectify
these problems, the success of these efforts cannot be predicted until the year
2000 actually arrives. The Company will upgrade or replace certain automated
systems before the year 2000; however some of these systems would have been
replaced before the year 2000 without regard to year 2000 compliance issues, due
to technology updates and Company expansion. In 1998, the Company established an
accrual for Year 2000 related costs incurred in 1998 of $160,000. This accrual
was established for consulting costs associated with on-going Year 2000 efforts
and equipment replacement.
Management does not believe that expenses related to meeting the Company's year
2000 challenges will have a material effect on the operations or financial
performance of the Company. However, factors beyond the control of management,
such as the effects on vendors of our mission-critical software and systems, the
effects of year 2000 issues on the economy, and the development of the risks
identified below under "The Risks of the Company's Year 2000 Issues," among
other things, could have a material effect on the operations or financial
performance of the Company.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES. The year 2000 presents certain
risks to the Company and its operations. Some of these risks are present because
the Company purchases technology applications from other parties who face year
2000 challenges. Other of these risks are inherent in the business of banking or
are risks faced by many companies with stock traded on a national stock
exchange. Although it is impossible to identify every possible risk that the
Company may face moving into the new millennium, Management has to date
identified the following potential risks:
1. Commercial banks, such as the Company, may experience a contraction in
their deposit base, if a significant amount of deposited funds are
withdrawn by customers prior to the year 2000, and interest rates may
increase in the latter part of 1999. This potential deposit contraction
could make it necessary for the Company to change its sources of funding
and could materially impact future earnings. The Company has incorporated a
contingency plan for addressing this situation, should it occur, into its
asset and liability management policies. This plan includes maintaining the
<PAGE>
ability to borrow funds in an amount at least equal to 50% of the Company's
allowed borrowing from the Federal Home Loan Bank of Seattle. Significant
demand for funds by other banks could reduce the amount of funds available
for the Company to borrow. If insufficient funds are available from a
Federal Home Loan Bank or other correspondents, the Company may also sell
investment securities or other liquid assets to meet liquidity needs.
Despite these efforts, a significant deposit contraction could materially
impact the Company's earnings or future operations, particularly if funds
availability at the Federal Home Loan Bank is impaired.
2. The Company lends significant amounts to businesses in its' market area.
If these businesses are adversely affected by year 2000 issues, their
ability to repay loans could be impaired. This increased credit risk could
affect the Company's financial performance. During the assessment phase of
the Company's Y2K Plan, significant borrowers were identified. Management
is currently monitoring the year 2000 compliance efforts of these credit
customers.
3. The Company's operations, like those of many other companies, can be
affected by the year 2000 triggered failures of other companies upon whom
the Company depends for the functioning of its automated systems.
Accordingly, the Company's operations could be materially affected, if the
operations of those companies who provide the Company with mission critical
applications, systems, and services are materially affected. As described
previously, the Company has identified its mission-critical vendors and is
monitoring their year 2000 compliance progress.
4. All companies with stock traded on a national stock exchange, including
the Company, could experience a drop in stock price as investors change
their investment portfolios or sell stock prior to the new millennium. At
this time, it is impossible to predict whether or not this will in fact be
the case with respect to the stock of the Company or any other company.
5. The Company's ability to operate effectively in the year 2000 could be
affected by communications abilities and access to utilities, such as
electricity, water, telephone, and others, to the extent access is
interrupted due to the effects of year 2000 issues on these and other
utilities.
THE COMPANY'S CONTINGENCY PLANS. The Company has developed contingency plans
related to year 2000 issues. These plans range from obtaining mission-critical
system back-up capabilities to funds management contingencies.
FORWARD LOOKING STATEMENTS. The previous discussion, entitled "Year 2000
Issues," includes certain "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 ("PSLRA"). This statement is
included for the express purpose of availing the Company of the protections of
the safe harbor provisions of the PSLRA. Management's ability to predict results
or effects of issues related to the year 2000 is inherently uncertain, and is
subject to factors that may cause actual results to differ materially from those
projected. Factors that could affect the actual results include the possibility
that protection procedures, contingency plans, and remediation efforts will not
operate as intended, and the Company's failure to timely or completely identify
all software or hardware applications requiring remediation, unexpected costs,
and the uncertainty associated with the impact of year 2000 issues on the
banking industry and on the Company's customers, vendors, and others with whom
it does business. Readers are cautioned not to place undue reliance on these
forward looking statements.
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
OVERVIEW. Interest rate, credit, and operations risks are the most significant
risks impacting the Company's performance. Other types of market risk, such as
foreign currency exchange rate risk and commodity price risk do not arise in the
normal course of the Company's business activities. The Company relies on loan
reviews, prudent loan underwriting standards and an adequate reserve for loan
loss to mitigate credit risk.
The Company defines interest sensitivity (or interest rate risk) as the risk
that the Company's earnings or capital will change when interest rates change.
Market, or economic risk, by comparison, is the risk that the value of the
Company's assets will change when interest rates change. To ensure consistent
measurement, the Company has developed comprehensive Asset and Liability
Management policies that are followed by all affiliate banks.
"Exposure" is the change in pre-tax earnings, over a 12-month period, when the
Fed Funds rate changes. "Leverage" is the Company's exposure calculated as a
percent of capital and therefore is expressed in terms of a pre-tax Return on
Equity.
If the Company's earnings move in the same direction as interest rates, then the
Company is "asset sensitive" (i.e. interest income changes more than interest
expense). If the earnings move in the opposite direction from the change in
rates, then the Company is "liability sensitive" (i.e. interest expense changes
more than interest income).
CALCULATION OF INTEREST RATE RISK. A change in earnings as a result of changes
in interest rates is caused by two factors. First, the rate on each asset and
liability changes by a different amount and at a different time. Second, there
are different volumes of assets and liabilities maturing and repricing (the
traditional gap). The combination causes a change in the Company's net interest
margin.
EXPOSURE CALCULATION OF INTEREST RATE RISK: The Company will use change in
earnings exposure as its primary measure of interest rate risk. It is the policy
of the Company to control the exposure of the Company's earnings to changing
interest rates by generally maintaining a position within a reasonable range
around an "earnings neutral" or "balanced" position. This is defined as the mix
of assets and liabilities that generate a net interest margin that is not
affected by interest rate changes.
There are three reasons for establishing a target range rather than an exact
earnings neutral position. Measuring interest rate risk is not an exact science.
We can only estimate the earnings impact of a change in rates, and this estimate
may change as the rate environment changes (this is often called "basis risk").
Also, the mix of assets and liabilities available in the Company's market may
not produce an exact earnings neutral position, thus forcing the Company to
forego good business opportunities if it must keep a totally balanced position.
Lastly, a neutral position does not allow the Company to modestly position
itself to take advantage of a rising or falling rate trend (i.e. keeping
investments shorter when rates are rising).
There can be exceptions to this general rule. If, for example, the Company has a
liquidity or capital problem then this takes priority and the Company would
employ a strategy that protects liquidity by maintaining an asset sensitive
position (i.e. having assets that will reprice quickly to reflect a change in
interest rates). This would keep assets at current rates to allow their sale, if
needed, without recognizing a significant loss.
Interest Rate Risk Exposure/Leverage Limits:
- --------------------------------------------
The Company shall normally maintain a mix of assets and liabilities that
produces interest rate risk that will change the Company's net interest income
over the next 12 months less than the following limits, if the Fed Funds rate
changes 2%:
Change in ROE
Leverage
--------
Asset sensitive 4.0%
Liability sensitive 2.0%
<PAGE>
There is a lower risk limit for liability sensitivity because, in a liability
sensitive Company, interest rate risk and market risk move in the same
direction, thereby exaggerating the impact of changing rates. If the Company
were asset sensitive, these two risks would tend to offset each other.
Interest rate risk is calculated quarterly and reported to the Asset/Liability
Management Committee and then to the respective Boards of Directors. Significant
changes in the structure of the Company's finances can be modeled during the
quarters to ensure continued compliance with these policy limits. At no time
during 1998 were these limitations exceeded. Management has assessed these
limits and believes that there has been no material change since December 31,
1998.
INFLATION
The primary impact of inflation on the Company's operations is increased asset
yields, deposit costs and operating overhead. Unlike most industrial companies,
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, interest rates generally have a more
significant impact on a financial institution's performance than the effects of
general levels of inflation. Although interest rates do not necessarily move in
the same direction or to the same extent as the prices of goods and services,
increases in inflation generally have resulted in increased interest rates. The
effects of inflation can magnify the growth of assets, and if significant, would
require that equity capital increase at a faster rate than would otherwise be
necessary.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
None.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
The following exhibit is being filed here with:
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K.
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATED: April 30, 1999.
SECURITY BANK HOLDING COMPANY
By: /s/ Charles D. Brummel
------------------------------------
Charles D. Brummel
Chairman and Chief Executive Officer
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
The Consolidated balance sheets and consolidated statements of operations of the
company's form 10-Q for the year to date
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 9,258
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<ALLOWANCE> 2,369
<TOTAL-ASSETS> 276,267
<DEPOSITS> 233,434
<SHORT-TERM> 8,491
<LIABILITIES-OTHER> 3,632
<LONG-TERM> 0
0
0
<COMMON> 22,291
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<TOTAL-LIABILITIES-AND-EQUITY> 276,267
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<INCOME-PRE-EXTRAORDINARY> 605
<EXTRAORDINARY> 0
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<NET-INCOME> 605
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
<YIELD-ACTUAL> 4.54
<LOANS-NON> 796
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<ALLOWANCE-OPEN> 2,294
<CHARGE-OFFS> 51
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