<PAGE 1>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
Commission File No. 1-14473
Sky Financial Group, Inc.
(Exact Name of Registrant as Specified in its Charter)
Ohio 34-1372535
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
221 South Church Street, Bowling Green, Ohio 43402
(Address of Principal Executive Offices) (Zip Code)
(419)327-6300
(Registrant's Telephone Number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ] No [ ]
The number of shares outstanding of the Registrant's common stock, without par
value was 44,980,587 at April 30, 1999.
<PAGE 2>
SKY FINANCIAL GROUP, INC.
INDEX
PART I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Consolidated Statement of Condition (Unaudited)
March 31, 1999 and December 31, 1998 3
Consolidated Statement of Earnings (Unaudited)
Three months ended March 31, 1999 and 1998 4
Consolidated Statement of Changes in
Shareholders' Equity (Unaudited)
Three months ended March 31, 1999 5
Consolidated Statements of Comprehensive
Income (Unaudited)
Three months ended March 31, 1999 and 1998 5
Consolidated Statement of Cash Flows (Unaudited)
Three months ended March 31, 1999 and 1998 6
Notes to Consolidated Financial Statements
(Unaudited) 7
Item 2. Management's Discussion and Analysis and
Statistical Information 13
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote
of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
EXHIBIT INDEX 24
<PAGE 3>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SKY FINANCIAL GROUP, INC.
Consolidated Balance Sheets (Unaudited)
(Dollars in thousands) March 31, December 31,
1999 1998
ASSETS
Cash and due from banks $ 153,997 $ 165,946
Interest-bearing deposits
with financial institutions 5,989 9,851
Federal funds sold 31,096 26,024
Loans held for sale 15,402 77,471
Securities available for sale 969,941 996,426
Total loans 3,337,426 3,355,881
Less allowance for credit losses (55,149) (54,008)
Net loans 3,282,277 3,301,873
Premises and equipment 87,441 85,966
Accrued interest receivable
and other assets 136,877 151,564
TOTAL ASSETS $4,683,020 $4,815,121
LIABILITIES
Deposits
Non-interest-bearing deposits $ 445,238 $ 483,487
Interest-bearing deposits 3,294,981 3,349,175
Total deposits 3,740,219 3,832,662
Securities sold under repurchase
agreements and federal funds
purchased 215,098 207,458
Debt and FHLB advances 317,471 357,771
Accrued interest payable
and other liabilities 61,007 73,388
TOTAL LIABILITIES 4,333,795 4,471,279
SHAREHOLDERS' EQUITY
Serial preferred stock,
$10.00 par value;
10,000,000 shares authorized;
none issued -- --
Common stock, no par value;
150,000,000 shares authorized;
45,082,750 and 45,082,890 shares
issued in 1999 and 1998 310,773 311,360
Retained earnings 38,475 27,816
Treasury stock; 106,562 and
57,063 shares in 1999 and 1998 (3,041) (1,500)
Accumulated other comprehensive
income 3,018 6,166
TOTAL SHAREHOLDERS' EQUITY 349,225 343,842
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $4,683,020 $4,815,121
<PAGE 4>
SKY FINANCIAL GROUP, INC.
Consolidated Statements of Income (Unaudited)
(Dollars in thousands, Three Months Ended
except per share data) March 31,
1999 1998
Interest Income
Loans, including fees $73,238 $72,061
Securities
Taxable 13 023 15,315
Nontaxable 1,166 921
Federal funds sold and other 272 945
Total interest income 87,699 89,242
Interest Expense
Deposits 33,703 36,624
Borrowed funds 7,612 6,949
Total interest expense 41,315 43,573
Net Interest Income 46,384 45,669
Provision for Credit Losses 2,360 1,976
Net Interest Income After
Provision Credit Losses 44,024 43,693
Other Income
Trust department income 1,310 1,225
Service charges and fees on
deposit accounts 4,164 3,545
Mortgage banking income 5,996 6,246
Brokerage commissions 2,889 2,223
Collection agency fees 599 1,397
Net securities gains 78 133
Net gains on sales of
commercial financing loans 4,906 4,150
Other income 4,567 4,113
Total other income 24,509 23,032
Other Expense
Salaries and employee benefits 20,938 22,905
Occupancy and equipment expense 6,477 6,361
Merger, integration, and
restructuring expense 3,932
Other operating expense 11,526 14,363
Total other expenses 38,941 47,561
Income Before Income Taxes 29,592 19,164
Income taxes 9,428 5,947
Net Income $20,164 $13,217
Earnings per Common Share:
Basic $ 0.45 $ 0.29
Diluted $ 0.44 $ 0.29
<PAGE 5>
SKY FINANCIAL GROUP, INC.
Consolidated Statement of Changes in Shareholders' Equity
(Dollars in thousands)
Accumulated
Other
Common Retained Treasury Comprehensive
Stock Earnings Stock Income Total
Balance
December 31, 1998 $311,360 $27,816 $(1,500) $ 6,166 $343,842
Net income 20,164 20,164
Common cash
dividends
($.21 per share) (9,455) (9,455)
Unrealized losses
on securities
available for
sale (3,148) (3,148)
Treasury shares
acquired (2,740) (2,740)
Treasury shares
issued for
stock options (588) 1,199 611
Fractional shares
and other items 1 (50) (49)
Balance
March 31, 1999 $310,773 $38,475 $(3,041) $ 3,018 $349,225
SKY FINANCIAL GROUP, INC.
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended
(Dollars in thousands) March 31,
1999 1998
Net Income $20,164 $13,217
Other comprehensive income:
Unrealized losses arising during
period (4,758) (188)
Reclassification adjustment for
gains included in income (78) (133)
Net unrealized loss on securities
available for sale (4,836) (321)
Tax effect 1,688 113
Total other comprehensive loss (3,148) (208)
Comprehensive Income $17,016 $13,009
<PAGE 6>
SKY FINANCIAL GROUP, INC.
Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands) Three Months Ended March 31,
1999 1998
Net Cash From Operating Activities $ 93,689 $ 4,749
Investing Activities
Net decrease (increase) in interest-
bearing deposits in other banks 3,862 (1,363)
Net increase in federal funds sold (5,072) (34,696)
Securities available for sale:
Proceeds from maturities and payments 138,449 87,450
Proceeds from sales 2,459 10,458
Purchases (119,889) (137,192)
Securities held to maturity:
Proceeds from maturities and payments -- 20,260
Purchases -- (395)
Proceeds from sales of loans 3,342 2,178
Net decrease (increase) in loans 13,817 (4,463)
Purchases of premises and equipment (6,372) (3,057)
Purchases of life insurance contracts (2,652) --
Proceeds from sales of premises and equipment 2,773 63
Proceeds from sales of other real estate 387 4
Net Cash From Investing Activities 31,104 (60,753)
Financing Activities
Net (decrease) increase in deposit accounts (92,443) 51,488
Net increase (decrease) in federal funds
and repurchase agreements 7,640 (10,795)
Net (decrease) in short-term FHLB advances (34,731) (67,210)
Proceeds from issuance of debt
and long-term FHLB advances -- 108,000
Repayment of debt and long-term FHLB advances (5,569) (17,299)
Cash dividends and fractional shares paid (9,461) (7,066)
Proceeds from issuance of common stock 611 980
Treasury stock purchases (2,740) (22,131)
Other items (49) (559)
Net Cash From Financing Activities (136,742) 35,408
Net Decrease in Cash and Due From Banks (11,949) (20,596)
Cash and Due From Banks at Beginning of Year 165,946 175,958
Cash and Due From Banks at End of Period $ 153,997 $ 155,362
Noncash transactions:
Securitization of loans held for sale $ -- $ 241
<PAGE 7>
SKY FINANCIAL GROUP, INC.
Notes to Consolidated Financial Information (Unaudited)
(Dollars in thousands, except per share data)
1. Accounting Policies
Sky Financial Group, Inc. (the Company) is a bank holding company
headquartered in Bowling Green, Ohio, which owns and operates three banks
primarily engaged in the commercial banking business. The Company also
operates businesses relating to collection services, broker-dealer operations,
commercial finance lending, and other financial related services.
The accounting and reporting policies followed by Sky Financial Group, Inc.
conform to generally accepted accounting principles and to general practices
within the financial services industry. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements. Actual results could
differ from those estimates. The allowance for loan losses and fair values of
financial instruments are particularly subject to change.
The consolidated financial statements of the Company include the accounts of
The Citizens Banking Company (Citizens), Mid Am Bank, The Ohio Bank (Ohio
Bank), Sky Asset Management Services, Inc. (SAMSI), Sky Investments, Inc.
(SII), Mid Am Credit Corp. (MACC), Mid Am Financial Services, Inc. (MAFSI),
Sky Insurance, Inc. (Sky Insurance), Mid Am Private Trust, N.A. (MAPT),
Sky Technology Resources, Inc. (Sky Tech), Mid Am Capital Trust I (MACT) and
various other insignificant subsidiaries. All significant intercompany
transactions and accounts have been eliminated in consolidation.
2. New Accounting Pronouncements
Beginning January 1, 2000, a new accounting standard will require all
derivatives to be recorded at fair value. Unless designated as hedges,
changes in these fair values will be recorded in the income statement. Fair
value changes involving hedges will generally be recorded by offsetting gains
and losses on the hedge and on the hedged item, even if the fair value of the
hedged item is not otherwise recorded. This is not expected to have a
material effect, but the effect will depend on derivative holdings when this
standard applies.
Mortgage loans originated in mortgage banking are converted into securities on
occasion. A new accounting standard for 1999 will allow classifying these
securities as available for sale, trading, or held to maturity, instead of the
current requirement to classify as trading. This is not expected to have a
material effect, but the effect will vary depending on the level and
designation of securitizations as well as on market price movements.
<PAGE 8>
3. Mergers, Acquisitions, Business Formations and Divestitures
On May 1, 1999, Sky Financial Group, Inc. completed its acquisition of
Picton Cavanaugh, Inc., a full service insurance agency which provides a wide
array of property, casualty, surety, professional liability, health, life and
executive benefit insurance products to individuals and businesses nationwide.
Picton Cavanaugh was formed in 1898 and is headquartered in Toledo, Ohio.
Under the terms of the transaction, shareholders of Picton Cavanaugh received
289,018 shares of the Company's common stock in a tax-free exchange to be
accounted for as a pooling of interests.
Effective December 17, 1998, the Company executed a definitive agreement with
Wood Bancorp, Inc. and its affiliate, First Federal Bank, Bowling Green, Ohio.
First Federal Bank is a $167 million federal savings bank with seven offices
in northwest Ohio. Wood Bancorp shareholders will receive 0.7315 shares of
Company common stock for each share of Wood Bancorp stock in a tax-free
exchange to be accounted for as a pooling of interests. Approximately 2.1
million Company common shares are expected to be issued in the merger. It is
anticipated that the transaction will be completed in the third quarter of
1999, pending regulatory approvals and approval of Wood Bancorp's
shareholders. Immediately following the affiliation, First Federal will be
merged into Mid Am Bank.
Effective December 14, 1998, the Company executed a definitive agreement to
acquire First Western Bancorp, Inc., a $2.2 billion bank holding company
headquartered in New Castle, Pennsylvania. First Western shareholders will
receive 1.211 shares of Company common stock for each share of First Western
common stock in a tax-free exchange to be accounted for as a pooling of
interests. Approximately 13.5 million Company common shares are expected to
be issued in the merger. It is anticipated that the transaction will be
completed in the third quarter of 1999, pending regulatory and shareholder
approvals. First Western's bank affiliate, First Western Bank, N.A., will be
merged into Citizens immediately following the affiliation.
Effective December 4, 1998, The Ohio Bank, Findlay, Ohio, affiliated with the
Company in a transaction accounted for as a pooling of interests.
Shareholders of The Ohio Bank received 69.575 Company common shares of stock
in exchange for each share of The Ohio Bank stock owned, with cash paid in
lieu of fractional shares. A total of 5.8 million Company common shares were
issued in the merger. The Ohio Bank had assets of approximately $600 million,
with 17 banking offices in western, central and northeastern Ohio. The Ohio
Bank is operated as a wholly-owned subsidiary of the Company.
Effective October 2, 1998, Citizens Bancshares, Inc. (Bancshares) and Mid Am,
Inc. (Mid Am) affiliated in a merger-of-equals transaction which was accounted
for as a pooling of interests. In conjunction with the merger, Bancshares
changed its name to Sky Financial Group, Inc. Shareholders of Mid Am received
0.847 shares of Company common stock for each share of Mid Am stock owned,
with cash paid in lieu of fractional shares. A total of 19.8 million Company
common shares were issued in the merger. Mid Am had assets of approximately
$2.3 billion, with 83 banking offices located in western Ohio and southern
Michigan.
<PAGE 9>
Effective May 12, 1998, Century Financial Corporation, Rochester, Pennsylvania
(CFC), merged into the Company. The transaction was affected through the
exchange of 0.8719 common shares of Company common stock for each of Century's
outstanding common shares, with cash paid in lieu of fractional shares. A
total of 4.5 million Company common shares were issued in the merger. CFC had
assets of approximately $453 million with 13 branches in Beaver and Butler
counties in Pennsylvania. Century National Bank, CFC's bank subsidiary, is
now operated as part of Citizens's branch network.
Effective March 6, 1998, UniBank, Steubenville, Ohio, affiliated with the
Company by merging into Citizens. The transaction was affected through the
exchange of 29.15 common shares of Company common stock for each of UniBank's
outstanding common shares, with cash paid in lieu of fractional shares. A
total of 2.1 million Company common shares were issued in the merger. UniBank
had assets of approximately $216 million with 12 offices in Jefferson and
Columbiana counties in Ohio, and is operated as part of Citizen's branch
network.
4. Merger, Integration and Restructuring Expenses
In 1998, the Company recorded merger, integration and restructuring charges
totaling $54,487 ($38,382 after tax). The majority of the charges were
associated with the merger and integration of the combined operations of
Citizens Bancshares, Inc., Mid Am, Inc. and The Ohio Bank. As of March 31,
1999, the remaining unpaid charges were $10,744, the majority of which are
expected to be paid during the second quarter of 1999.
5. Capital Resources
The Federal Reserve Board (FRB) has established risk-based capital guidelines
that must be observed by bank holding companies and banks. Under these
guidelines, total qualifying capital is categorized into two components:
Tier I and Tier II capital. Tier I capital generally consists of common
shareholders' equity, perpetual preferred stock (subject to limitations) and
minority interests in subsidiaries. Subject to limitations, Tier II capital
includes certain other preferred stock and debentures, and a portion of the
reserve for credit losses. These ratios are expressed as a percentage of
risk-adjusted assets, which include various risk-weighted percentages of
off-balance sheet exposures, as well as assets on the balance sheet. The FRB
regulations governing the various capital ratios do not recognize the effects
of SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities" on capital relating to changes in market value of securities
available for sale.
At March 31, 1999, a minimum Tier I capital ratio of 4.00% and a total capital
ratio of 8.00% were required. The Company's qualifying capital at March 31,
1999 exceeded both the Tier I and Tier II risk-based capital guidelines. In
addition, a capital leverage ratio is used in connection with the risk-based
capital standards which is defined as Tier I capital divided by total average
assets adjusted for certain items. Included in Tier I capital are $23,600 of
10.20% capital securities issued by the Company through a special purpose
trust subsidiary in 1997. The following table presents the various capital
and leverage ratios of the Company.
<PAGE 10>
March 31, 1999 December 31, 1998
Total adjusted average assets
for leverage ratio $4,806,384 $4,798,176
Risk-weighted assets and
off-balance-sheet financial
instruments for capital ratio 3,847,861 3,893,627
Tier I capital 355,988 345,122
Total risk-based capital 461,413 450,025
Leverage ratio 7.4% 7.2%
Tier I capital ratio 9.3 8.9
Total capital ratio 12.0 11.6
Capital ratios applicable to the Company's banking subsidiaries at March 31,
1999 were as follows:
Total
Tier I Risk-based
Leverage Capital Capital
Regulatory Capital Requirements
Minimum 4.0 4.0 8.0
Well-capitalized 5.0 6.0 10.0
Bank Subsidiaries
Mid Am Bank 7.2 8.7 10.9
Citizens 5.5 8.7 10.8
Ohio Bank 6.4 8.6 10.9
In October, 1998, the Board of Directors of the Company authorized management
to undertake purchases of up to 1,980,000 shares of the Company's outstanding
common stock over a twelve month period in the open market or in privately
negotiated transactions. The shares reacquired are held as treasury stock and
reserved for use in the Company's stock option plan and for future stock
dividend declarations. As of March 31, 1999, the Company had repurchased
approximately 189,000 shares of common stock pursuant to its 1998 repurchase
program. Subsequent to March 31, 1999, the Company has repurchased 60,500
additional shares of common stock.
6. Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted
average number of shares outstanding during the period. Diluted earnings per
share is computed using the weighted average number of shares determined for
the basic computation plus the number of shares of common stock that would be
issued assuming all contingently issuable shares having a dilutive effect on
earnings per share were outstanding for the period.
<PAGE 11>
The weighted average number of common shares outstanding for basic and diluted
earnings per share computations were as follows:
Three Months Ended
March 31,
1999 1998
Numerator:
Net income $ 20,164 $ 13,217
Denominator:
Weighted-average common
shares outstanding (basic) 44,999,000 45,365,000
Exercise of options 464,000 613,000
Weighted-average common
shares outstanding (diluted) 45,463,000 45,978,000
Earnings per share:
Basic $ 0.45 $ 0.29
Diluted $ 0.44 $ 0.29
7. Line of Business Reporting
The Company manages and operates two major lines of business: Community
Banking and Financial Service Affiliates. Community Banking includes lending
and related services to businesses and consumers, mortgage banking, deposit-
gathering and institutional trust services. Financial Service Affiliates
consist of non-banking companies engaged in commercial finance lending and
leasing, broker/dealer operations, non-conforming mortgage lending, collection
activities, wealth management and other financial related services. The
business lines are identified by the entities through which the product or
service is delivered.
The reported line of business results reflect the underlying core operating
performance within the business units. Parent and Other is comprised of the
parent company and several smaller business units. It includes the net
funding cost of the parent company and intercompany eliminations. Expenses
for centrally provided services and support are fully allocated based
principally upon estimated usage of services. All significant non-recurring
items of income and expense company-wide are included in Parent and Other.
Substantially all of the Company's assets are part of the Community Banking
line of business. Prior periods have been presented to conform with current
reporting methodologies. Selected segment information is included in the
following table.
<PAGE 12>
Financial Parent
Three Months Ended Community Service and Consolidated
March 31, Banking Affiliates Other Total
1999
Net interest income $47,007 $ 522 $(1,145) $46,384
Provision for loan losses 2,318 42 0 2,360
Net interest income
after provision 44,689 480 (1,145) 44,024
Non-interest income 14,042 10,543 (76) 24,509
Non-interest expense 29,266 10,428 (753) 38,941
Income (loss) before
income taxes 29,465 595 (468) 29,592
Income taxes 9,394 244 (210) 9,428
Net income (loss) $20,071 $ 351 $ (258) $20,164
1998
Net interest income $46,175 $ 209 $ (715) $45,669
Provision for loan losses 1,963 14 (1) 1,976
Net interest income
after provision 44,212 195 (714) 43,693
Non-interest income 14,296 9,045 (309) 23,032
Non-interest expense 34,701 8,933 3,927 47,561
Income (loss) before
income taxes 23,807 307 (4,950) 19,164
Income taxes 7,251 144 (1,448) 5,947
Net income (loss) $16,556 $ 163 $(3,502) $13,217
<PAGE 13>
Item 2. Management's Discussion and Analysis and Statistical Information
(Dollars in thousands, except per share data)
Three Months Ended March 31, 1999 and 1998
Results of Operations
Net income for the first quarter of 1999 was $20,164, an increase of $6,947
or 53% over the first quarter of 1998 earnings of $13,217. Diluted earnings
per common share for the first quarter of 1999 was $.44 ($.45 basic), up 52%
when compared to $.29 ($.29 basic) for the same period in 1998. Return on
average equity (ROE) for the first quarter of 1999 was 23.35% while return on
average assets (ROA) was 1.73%. This compares to ROE and ROA ratios of 14.21%
and 1.17%, respectively, for the first quarter of 1998. Reported net income
for the first quarter of 1998 includes after-tax non-recurring items which
reduced net income $2,850 or $.06 per diluted share.
Operating earnings, which exclude the after-tax non-recurring items, increased
$4,097 or 26% to $20,164 for the first quarter of 1999 as compared to $16,067
for the same period in 1998. Operating earnings per diluted share for 1999
increased 26% to $.44 from $.35 in 1998. On this same basis, ROE was 23.35%
and ROA was 1.73% in 1999 compared to 17.28% and 1.42%, respectively, in 1998.
Business Line Results
Sky Financial Group, Inc. is managed along two major lines of business: the
community banking group and the financial service affiliates. The community
banking group is comprised of the Company's three commercial banks: Citizens,
Mid Am Bank and Ohio Bank. The financial service affiliates include the
Company's non-banking subsidiaries, which operate businesses relating to
commercial finance lending and leasing, broker-dealer operations, non-
conforming mortgage lending, collection activities, wealth management and
other financial related services.
The Company's business line results for the first quarter ended March 31, 1999
and 1998 are summarized in the table below.
Net Income (Loss)
Quarter ended March 31, 1999 1998
Community Banking $ 20,071 $ 16,556
Financial Service Affiliates 351 163
Parent and Other (258) (3,502)
Consolidated $ 20,164 $ 13,217
The increase in community banking net income in 1999 was primarily due to
reductions in non-interest expense. The efficiency ratio was 46.9% for the
first quarter of 1999 compared to 56.3% in the first quarter of 1998. The
1999 community banking results reflect a ROE of 25.76% and a ROA of 1.73%
compared to 18.78% and 1.48%, respectively, in the first quarter of 1998.
<PAGE 14>
The financial service affiliates' earnings reflect the Company's continued
investment in the development and growth of these businesses. While earnings
remain modest, revenues have grown 20% in 1999.
Parent and other includes the net funding costs of the parent company and all
significant non-recurring items of income and expense. The first quarter 1998
results included merger, integration and restructuring costs of $3,932 ($2,850
after tax).
Net Interest Income
Net interest income increased $715 to $46,384 in the first quarter of 1999 as
compared to $45,669 for the same period in 1998. Net interest income, the
difference between interest income earned on interest-earning assets and
interest expense incurred on interest-bearing liabilities, is the most
significant component of the Company's earnings. Net interest income is
affected by changes in the volumes, rates and composition of interest-earning
assets and interest-bearing liabilities. The Company's net interest margin
for the three months ended March 31, 1999 was 4.40% compared to 4.42% for the
same period in 1998. The decline in the net interest margin is primarily due
to lower yields on earning assets, while funding costs were basically flat, as
increased reliance on higher cost borrowings offset the benefit of lower
deposit costs.
Provision for Credit Losses
The provision for credit losses increased $384 or 19% to $2,360 in the first
quarter of 1999 compared to $1,976 in the first quarter of 1998. The Company
increased its provision for credit losses in response to continued loan
portfolio growth and higher net charge-offs. Net charge-offs were $1,219 or
0.14% (annualized) of average loans during the three months ended March 31,
1999, compared to $860 or 0.11% (annualized) for the same period in 1998. The
provision for credit losses represents the charge to income necessary to
adjust the allowance for loan losses to an amount that represents management's
assessment of the estimated probable credit losses inherent in the Company's
loan portfolio which have been incurred at each balance sheet date.
March 31, December 31, March 31,
1999 1998 1998
Allowance for credit losses
as a percentage of loans 1.65% 1.61% 1.32%
Allowance for credit losses
as a percentage of
non-performing loans 455.02 431.68 349.55
Non-Interest Income
The increase in non-interest income reflects the emphasis of the Company on
expanding its fee-based businesses, diversifying its revenue sources and
adding to profitability beyond traditional banking products and services.
Non-interest income for the first quarter of 1999 was $24,509, an increase of
$1,477 or 6% from the $23,032 reported for the same quarter of 1998. The
increase was primarily due to an increase of $619 in service charges and fees
on deposit accounts, an increase of $756 in net gains on sales of loans at
MACC, the Company's commercial leasing and financing company, an increase of
<PAGE 15>
$666 in brokerage commissions and an increase of $533 in value in bank owned
life insurance. The increases were partially offset by a decrease of $798 in
collection agency fees and a decrease of $250 in mortgage banking revenue.
The increase in net gains on sales of commercial financing loans and brokerage
commissions was the result of increased volumes. The increase in value in
bank owned life insurance was due to the purchase of approximately $22,690 in
additional life insurance. The decrease in collection agency fees was
primarily due to a reorganization of the collection agency business. The
decrease in fees was partially offset by a corresponding decrease in expenses.
Non-Interest Expense
Non-interest expense for the first quarter of 1999 was $38,941, a decrease of
$8,620 or 18% from the $47,561 reported for the same quarter of 1998. The
decrease resulted from a $4,688, or 11% reduction in core operating expenses
and a $3,932 non-recurring merger and restructuring charge in the prior year.
Salaries and employee benefits which comprise the largest component of non-
interest expense decreased 9% in the first quarter of 1999 due to savings
realized from the consolidation of ten previously separate banks into three
banking units and elimination of duplicate positions. Occupancy expense and
equipment expense increased $116 or 2%. Brokerage commissions increased due
to an increase in the volume of transactions for the first quarter of 1999 as
compared to the same period for 1998. Other expenses decreased $3,199 or 25%
to $9,730 in 1999 from $12,929 in 1998. The decrease in other expenses was
primarily due to efficiencies realized from the conversion and integration of
systems and processes within the Company.
Income Taxes
The provision for income taxes for the first quarter of 1999 increased $3,481,
or 59%, to $9,428 compared to $5,947 for the same period in 1998 due to an
increase in pre-tax income. The effective tax rate for the first quarter of
1999 was 31.9% as compared to 31.0% for the same period in 1998.
Asset Quality
The following table presents the aggregate amounts of non-performing assets
and respective ratios on the dates indicated.
March 31, December 31, March 31,
1999 1998 1998
Non-accrual loans $ 9,856 $10,619 $11,399
Restructured loans 2,264 1,892 471
Total non-performing loans 12,120 12,511 11,870
Other real estate owned 1,430 1,330 980
Total non-performing assets $13,550 $13,841 $12,850
Loans 90 days or more past due
and not on non-accrual $ 9,795 $ 4,061 $ 5,449
<PAGE 16>
Non-performing loans to
total loans 0.36% 0.37% 0.38%
Non-performing assets to
total loans plus other
real estate owned 0.41 0.41 0.41
Allowance for credit losses to
total non-performing loans 455.02 431.68 349.55
Loans 90 days or more past due
and not on non-accrual to
total loans 0.29 0.12 0.17
The Ohio Bank and Mid Am Bank have outstanding lease receivables and loans
with an aggregate outstanding balance at March 31, 1999 of $712 to The
Bennett Funding Group, Inc. and related entities (Bennett) which remain
subject to the Bennett bankruptcy proceeding commenced in March 1998. In
December 1997 and January 1998, the bankruptcy judge ruled that The Ohio Bank
and Mid Am Bank, respectively, were secured creditors with respect to certain
of their outstanding Bennett portfolios. These decisions have been appealed
by the bankruptcy trustee and the appeals are pending. No decision has been
rendered with respect to $712 in loans from The Ohio Bank and Mid Am Bank
which present different issues from the issues rendered by the bankruptcy
judge. The Bennett loans are included in non-accrual loans.
Loans now current but where some concerns exist as to the ability of the
borrower to comply with present loan repayment terms, excluding non-performing
loans, approximated $22,492 and $23,168 at March 31, 1999 and December 31,
1998, respectively, and are being closely monitored by management and the
Boards of Directors of the subsidiaries. The classification of these loans,
however, does not imply that management expects losses on each of these loans,
but rather that a higher level of scrutiny is prudent under the
circumstances. The decrease in loans where some concern exists is primarily
attributable to the Company's continuous process of loan review, which has
identified various improvements in the financial condition of certain of the
individual borrowers. In the opinion of management, these loans require close
monitoring despite the fact that they are performing according to their terms.
Such classifications relate to specific concerns relating to each individual
borrower and do not relate to any concentrated risk elements common to all
loans in this group.
As of March 31, 1999, the Company did not have any loan concentrations which
exceeded 10% of total loans.
The following table presents a summary of the Company's credit loss experience
for the three months ended March 31, 1999 and 1998.
1999 1998
Balance of allowance at
beginning of year $54,008 $40,376
Loans charged-off:
Real estate 307 136
Commercial and agricultural 580 1,141
Installment and credit card 1,021 1,329
Other loans
Total loans charged-off 1,908 2,606
<PAGE 17>
Recoveries:
Real estate 72 68
Commercial and agricultural 220 1,320
Installment and credit card 383 335
Other loans 14 23
Total recoveries 689 1,746
Net loans charged-off 1,219 860
Provision charged to operating
expense 2,360 1,976
Balance of allowance at
end of period $55,149 $41,492
Ratio of net charge-offs to
average loans outstanding 0.14% 0.11%
Allowance for credit losses
to total loans 1.65 1.32
Allowance for credit losses
to total non-performing loans 455.02 349.55
The Company maintains an allowance for credit losses at a level adequate to
absorb management's estimate of probable losses inherent in the loan
portfolio. The allowance is comprised of a general allowance, a specific
allowance for identified problem loans and an unallocated allowance.
The general allowance is determined by applying estimated loss factors to the
credit exposures from outstanding loans. For construction, commercial and
commercial real estate loans, loss factors are applied based on internal risk
grades of these loans. For residential real estate, installment, credit card
and other loans, loss factors are applied on a portfolio basis. Loss factors
are based on peer and industry loss data compared to the Company's historical
loss experience, and are reviewed for correction on a quarterly basis, along
with other factors affecting the collectability of the loan portfolio.
Specific allowances are established for all criticized and classified loans,
where management has determined that, due to identified significant
conditions, the probability that a loss has been incurred exceeds the general
allowance loss factor determination for those loans.
The unallocated allowance both recognizes the estimation risk associated with
the allocated general and specific allowances and incorporates management's
evaluation of existing conditions that are not included in the allocated
allowance determinations. These conditions are reviewed quarterly by
management and include general economic conditions, credit quality trends,
recent loss experience, bank regulatory examination results, and internal loan
review examination findings.
<PAGE 18>
The following table sets forth the Company's allocation of the allowance for
credit losses as of March 31, 1999 and December 31, 1998.
March 31, 1999 December 31, 1998
Construction $ 968 $ 693
Real estate 7,798 6,504
Commercial, financial
and agricultural 19,863 20,647
Installment and credit card 9,576 9,130
Other loans 1,052 1,820
Unallocated 15,892 15,214
Total $55,149 $54,008
Liquidity
The liquidity of a financial institution reflects its ability to provide funds
to meet requests, to accommodate possible outflows in deposits and to take
advantage of interest rate market opportunities. Funding of loan requests,
providing for liability outflows, and management of interest rate fluctuations
require continuous analysis in order to match the maturities of specific
categories of short-term loans and investments with specific types of deposits
and borrowings. Financial institution liquidity is this normally considered
in terms of the nature and mix of the institution's sources and uses of funds.
The Company's banking subsidiaries maintain adequate liquidity primarily
through the use of investment securities and unused borrowing capacity, in
addition to maintaining a stable core deposit base. At March 31, 1999,
securities and other short-term investments with maturities of one year or
less totaled $140,421, with additional liquidity provided by the remainder of
the investment portfolio. The banks utilize several short-term and long-term
borrowing sources. Each of the banking subsidiaries is a member of the
Federal Home Loan Bank (FHLB) and have lines of credit with the FHLB. At
March 31, 1999, these lines of credit enable the banks to borrow up to
$492,356, of which $211,704 is currently outstanding.
Since the Company is a holding company and does not conduct operations, its
primary sources of liquidity are borrowings from outside sources and dividends
paid to it by its subsidiaires. For the banking subsidiaries, regulatory
approval is required in order to pay dividends in excess of the subsidiaries'
earnings retained for the current year plus retained net profits for the prior
two years. As a result of these restrictions, dividends which could be paid
to the Company by its bank subsidiaries were limited to $544 at March 31,1999.
In March, 1999, the Company renegotiated an agreement with unrelated financial
institutions which enabled the Company to borrow up to $75,000 through
March 8, 2000. At March 31, 1999, the Company had borrowings of $30,000
under this agreement.
<PAGE 19>
Asset/Liability Management
Closely related to liquidity management is the management of interest-earning
assets and interest-bearing liabilities. The Company manages its rate
sensitivity position to avoid wide swings in net interest margins and to
minimize risk due to changes in interest rates. At March 31, 1999, the
Company had a manageable positive gap position and therefore does not expect
to experience any significant fluctuations in its net interest income as a
consequence of changes in interest rates.
Year 2000 Readiness
Since 1996, the Company has been reviewing the potential effects of the Year
2000 issue on the Company. Internally, the Company, through its project team
comprised of representatives of the Company and its affiliates, has invested
more than 15,000 hours to date on this project. The Company core project team
has met monthly addressing both internal and external issues. The team has
identified over 650 systems that could be potentially affected by the Year
2000 problem. These systems include all information technology systems and
computer chip embedded functions such as vaults, elevators, security systems,
heating and cooling equipment and other operating facilities. The Company's
efforts have been directed by a 5-phase plan to be completed in preparation
for the Year 2000. The phases include awareness, assessment, renovation,
validation and implementation, and were established by the federal agencies
which regulate financial institutions.
Four federal agencies share the responsibility to make sure financial
institutions are Year 2000 compliant. These agencies are conducting special
examinations of insured banks to see that they are taking the necessary steps
to be prepared for the century date change. The Company and its affiliates
are working closely with these regulators following their specific criteria to
assess our progress in Year 2000 readiness.
With regard to information technology systems, the Company utilizes standard
industry hardware and widely used, licensed banking software for most of its
information technology needs. The software packages are purchased, and the
Company utilizes such software without material program modifications.
Because of its reliance upon third parties, the Company has contacted its
hardware and software vendors to obtain assurances that its systems are Year
2000 compliant. Additionally, all mission critical hardware and software
systems (identified as 61 systems by the project team) will be tested and
validated prior to June 30, 1999. As of May 3, 1999, all mission critical
systems which have been tested have been deemed Year 2000 compliant.
Furthermore, the Company has completed all scheduled vendor inquiries and
testing for non-information technology systems, including building and banking
equipment.
Externally, the Company has contacted its business partners regarding their
Year 2000 preparedness. These partners include commercial customers, vendors,
service suppliers, data exchange vendors and utility companies. The Company's
affiliate banks have also sponsored educational seminars in select market
areas to educate commercial clients regarding Year 2000 issues.
<PAGE 20>
The Company has developed a comprehensive contingency plan in the unlikely
event critical systems fail to function after the century date changes.
Alternative methods of doing business have been developed and are in the
process of being tested. These methods address data gathering, customer
service procedures, and staffing needs before, during and after the Year 2000
changeover. This planning also includes non-compliance by third parties which
may affect the Company's ability to conduct business.
Notwithstanding the Company's efforts to date to replace or repair affected
systems and develop contingency plans for potential risks, if the Company does
not complete all activities associated with resolving its Year 2000 issues,
the Company could be materially adversely affected as a result of not being
able to process transactions related to its core business activities. In
addition, non-compliance by the Company's business partners, including without
limitation, the Company's business customers, vendors, service suppliers and
utilities, could have a material adverse affect on the Company.
The external costs of the Company's Year 2000 project is estimated at
$1,200,000. External costs include equipment replacement or upgrade, seminar
sponsorships, vendor payments, and customer communication and education.
Additionally, the Company estimates that internal costs will amount to
$500,000, comprised primarily of personnel expense.
Forward-Looking Statements
This report includes forward-looking statements by the Company relating to
such matters as anticipated operating results, prospects for new lines of
business, technological developments, economic trends (including interest
rates), reorganization transactions and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for forward-
looking statements, and the purpose of this paragraph is to secure the use of
the safe harbor provisions. While the Company believes that the assumptions
underlying the forward-looking statements contained herein and in other public
documents are reasonable, any of the assumptions could prove to be inaccurate,
and accordingly, actual results and experience could differ materially from
the anticipated results or other expectations expressed by the Company in its
forward-looking statements. Factors that could cause actual results or
experience to differ from results discussed in the forward-looking statements
include, but are not limited to: economic conditions; volatility and direction
of market interest rates; capital investment in and operating results on
non-banking business ventures of the Company; the ability of the Company's
broker/dealer subsidiary to recruit registered representatives; governmental
legislation and regulation; material unforeseen changes in the financial
condition or results of operations of the Company's customers; customer
reaction to and unforeseen complications with respect to the Company's
restructuring or integration of acquisitions; unforeseen difficulties in
realizing expected cost savings from acquisitions; product redesign
initiative; the effect of the year 2000 on the Company, its computer systems,
customers, vendors and service suppliers; and other risks identified, from
time-to-time in the Company's other public documents on file with the
Securities and Exchange Commission.
<PAGE 21>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The primary market risk to which the Company is exposed is interest rate risk.
The primary business of the Company and the composition of its balance sheet
consists of investments in interest-earning assets, which are funded by
interest-bearing liabilities. These financial instruments have varying levels
of sensitivity to changes in the market rates of interest, resulting in market
risk. None of the Company's financial instruments are held for trading
purposes.
One method the Company uses to manage its interest rate risk is a rate
sensitivity gap analysis. The Company also monitors its interest rate risk
through a sensitivity analysis, whereby it measures potential changes in its
future earnings and the fair values of its financial instruments that may
result from one or more hypothetical changes in interest rates. This analysis
is performed by estimating the expected cash flows of the Company's financial
instruments using interest rates in effect at March 31, 1999. The present
value of financial instruments is calculated using estimated cash flows based
on weighted-average contractual rates and terms, then discounted at the
estimated current market interest rate for similar financial instruments.
Hypothetical changes in interest rates are then applied to the financial
instruments, and the cash flows and fair values are again estimated using
these hypothetical rates. For the net interest income estimates, the
hypothetical rates are applied to the financial instruments based on the
assumed cash flows. The Company applies these interest rate shocks to its
financial instruments up and down 200 basis points.
The following table presents an analysis of the potential sensitivity of the
Company's annual net interest income and present value of the Company's
financial instruments to sudden and sustained 200 basis-point changes in
market interest rates.
March 31, December 31, ALCO
1999 1998 Guidelines
One Year Net Interest
Income Change
+200 Basis points (2.0)% (1.4)% (10.0)%
- -200 Basis points (0.1) (0.9) (10.0)
Net Present Value of
Equity Change
+200 Basis points (14.4) (12.1)% (30.0)%
- -200 Basis points 3.0 10.5 (30.0)
The projected volatility of net interest income and the net present value of
equity rates to a +/- 200 basis points change at March 31, 1999 fall within
the Board of Directors guidelines.
The above analysis is based on numerous assumptions, including relative levels
of market interest rates, loan prepayments and reactions of depositors to
changes in interest rates, and should not be relied upon as being indicative
of actual results. Further, the analysis does not necessarily contemplate all
actions the Company may undertake in response to changes in interest rates.
<PAGE 22>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in lawsuits and claims, which arise in the normal
course of business. In the opinion of management, any liabilities that may
result from these lawsuits and claims will not materially affect the financial
position or results of operations of the Company.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
1. Statement Re Computation of Earnings Per Common Share
(b) Reports on Form 8-K
The Company filed a report on Form 8-K with the Securities and Exchange
Commission as of February 12, 1999, to satisfy certain pooling of interests
accounting requirements relating to the Company's acquisition of The Ohio Bank
effective December 4, 1998.
<PAGE 23>
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 hereunto duly authorized.
SKY FINANCIAL GROUP, INC.
/s/ Kevin T. Thompson
Kevin T. Thompson
Executive Vice President / Chief Financial Officer
DATE: May 17, 1999
<PAGE 24>
SKY FINANCIAL GROUP, INC.
EXHIBIT INDEX
Exhibit No. Description Page Number
(11.1) Statement Re Computation of
Earnings Per Common Share
The information required by this exhibit is
incorporated herein by reference from the
information contained in Note 6 "Earnings
Per Share" on pages 10 and 11 of the
Company's Form 10-Q for March 31, 1999.
(27.1) Financial Data Schedule 25
(99.1) Form 8-K to satisfy accounting requirements
relating to the acquisition of The Ohio Bank.
The information required by this exhibit is
incorporated herein by reference from the
Company's Form 8-K dated February 12, 1999,
filed with the Securities and Exchange
Commission on February 12, 1999.