UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2005
Commission File Number: 0-26876
OAK HILL FINANCIAL, INC.
(Exact name of Registrant as specified in its charter)
Ohio 31-1010517
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
14621 S. R. 93 45640
Jackson, Ohio (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (740) 286-3283
Indicate by check mark whether the issuer (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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes X No
--- ---
As of August 7, 2005, the latest practicable date, 5,686,081 shares of the
Registrant's common stock, without par value, were outstanding.
Oak Hill Financial, Inc.
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Statements of Financial Condition 3
Consolidated Statements of Earnings 4
Consolidated Statements of Comprehensive Income 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial Condition
And Results of Operations 15
Item 3: Quantitative and Qualitative Disclosures About Market Risk 20
Item 4: Controls and Procedures 20
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 21
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds 21
Item 3: Default Upon Senior Securities 21
Item 4: Submission of Matters to a Vote of Security Holders 21
Item 5: Other Information 22
Item 6: Exhibits 22
Signatures 23
Certifications 24
-2-
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
Oak Hill Financial, Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)
June 30, December 31,
(In thousands, except share data) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 23,368 $ 31,009
Federal funds sold 841 988
Investment securities designated as available for sale - at market 121,772 88,383
Investment securities designated as held to maturity - at cost (approximate market
value of $3,970 and $3,853 at June 30, 2005 and December 31, 2004, respectively) 3,630 3,640
Loans receivable - net 997,869 912,282
Loans held for sale - at lower of cost or market
256
Office premises and equipment - net 19,225 15,489
Federal Home Loan Bank stock - at cost 7,426 6,590
Real estate acquired through foreclosure 744 1,614
Accrued interest receivable on loans 3,897 3,407
Accrued interest receivable on investment securities 849 527
Goodwill 7,456 1,674
Core deposit intangible 4,650 1,270
Bank owned life insurance 12,701 10,118
Prepaid expenses and other assets 2,883 2,505
Prepaid federal income taxes 3,956 2,929
Deferred federal income taxes -- 359
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,211,267 $ 1,083,040
===========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Demand $ 90,313 $ 88,712
Savings and time deposits 867,941 773,384
- ---------------------------------------------------------------------------------------------------------------------------
Total deposits 958,254 862,096
Securities sold under agreements to repurchase 18,748 5,359
Advances from the Federal Home Loan Bank 111,924 105,601
Notes payable -- 2,700
Subordinated debentures 23,000 18,000
Deferred federal income taxes payable 1,600 --
Accrued interest payable and other liabilities 4,220 4,241
- ---------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,117,746 997,997
Stockholders' equity
Common stock - $.50 stated value; authorized 15,000,000 shares
5,875,084 and 5,653,583 shares issued at June 30, 2005 and December 31, 2004 2,938 2,827
Additional paid-in capital 14,395 6,658
Retained earnings 80,012 78,071
Treasury stock (158,703 and 96,302 shares at June 30, 2005 and
December 31, 2004, respectively - at cost) (4,546) (3,118)
Accumulated comprehensive income:
Unrealized gain on securities designated as available for sale, net
of related tax effects 722 605
- ---------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 93,521 85,043
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,211,267 $ 1,083,040
===========================================================================================================================
-3-
Oak Hill Financial, Inc.
CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)
For the For the
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30,
- -----------------------------------------------------------------------------------------------------------------------
(In thousands, except share data) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $30,425 $26,839 $15,685 $13,540
Investment securities 2,235 1,594 1,291 769
Interest-bearing deposits and other 207 129 114 65
- -----------------------------------------------------------------------------------------------------------------------
Total interest income 32,867 28,562 17,090 14,374
INTEREST EXPENSE
Deposits 10,249 7,533 5,539 3,811
Borrowings 2,946 2,343 1,565 1,155
- -----------------------------------------------------------------------------------------------------------------------
Total interest expense 13,195 9,876 7,104 4,966
- -----------------------------------------------------------------------------------------------------------------------
Net interest income 19,672 18,686 9,986 9,408
Provision for losses on loans 5,459 1,283 4,709 708
- -----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 14,213 17,403 5,277 8,700
OTHER INCOME
Service fees, charges and other operating 3,270 2,502 1,863 1,316
Insurance commissions 1,361 1,512 690 775
Gain on sale of loans 542 900 224 605
Gain on sale of securities 370 202 227 68
- -----------------------------------------------------------------------------------------------------------------------
Total other income 5,543 5,116 3,004 2,764
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE
Employee compensation and benefits 7,576 7,078 3,994 3,638
Occupancy and equipment 2,053 1,620 1,051 787
Federal deposit insurance premiums 60 53 30 27
Franchise taxes 103 489 50 245
Other operating 4,178 3,684 2,339 1,894
Amortization of core deposit intangible 371 -- 299 --
Merger-related expenses 453 -- 136 --
- -----------------------------------------------------------------------------------------------------------------------
Total general, administrative and other expense 14,794 12,924 7,899 6,591
- -----------------------------------------------------------------------------------------------------------------------
Earnings before federal income taxes (benefits) 4,962 9,595 382 4,873
FEDERAL INCOME TAX (BENEFITS)
Current 137 3,001 (1,214) 1,409
Deferred 964 199 995 216
- -----------------------------------------------------------------------------------------------------------------------
Total federal income tax (benefits) 1,101 3,200 (219) 1,625
- -----------------------------------------------------------------------------------------------------------------------
NET EARNINGS $ 3,861 $ 6,395 $ 601 $ 3,248
=======================================================================================================================
EARNINGS PER SHARE
Basic $ .68 $ 1.15 $ .10 $ .59
=======================================================================================================================
Diluted $ .66 $ 1.12 $ .10 $ .57
=======================================================================================================================
-4-
Oak Hill Financial, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
For the For the
Six Months Ended Three Months Ended
---------------- ------------------
June 30, June 30,
(In thousands) 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------
Net earnings $ 3,861 $ 6,395 $ 601 $ 3,248
Other comprehensive income (loss), net of related tax effects:
Unrealized gains (losses) on securities designated as available
for sale, net of taxes (benefits) of $192, $(557), $707 and
$(720), respectively 356 (1,034) 1,312 (1,338)
Reclassification adjustment for realized gains included in net
earnings, net of taxes of $131, $71, $79 and $24, respectively (239) (131) (148) (44)
- ----------------------------------------------------------------------------------------------------------------
Comprehensive income $ 3,978 $ 5,230 $ 1,765 $ 1,866
================================================================================================================
Accumulated comprehensive income (loss) $ 722 $ (250) $ 722 $ (250)
================================================================================================================
-5-
Oak Hill Financial, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
For the Six Months Ended
------------------------
June 30,
(In thousands) 2005 2004
- ---------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings for the period $ 3,861 $ 6,395
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 868 510
Amortization of core deposit intangible 371
Gain on sale of securities (370) (202)
Amortization of premiums and discounts on investment
securities - net 398 516
Amortization of mortgage servicing rights 190 340
Proceeds from sale of loans in secondary market 17,701 31,299
Loans disbursed for sale in secondary market (17,128) (28,633)
Gain on sale of loans (317) (503)
Gain on disposition of assets (85) --
Amortization of deferred loan origination costs and fees - net (258) (65)
Proceeds from sale of other real estate owned 970 838
Loss on sale of other real estate owned 203 39
Federal Home Loan Bank stock dividends (163) (120)
Provision for losses on loans 5,459 1,283
Tax benefit of stock options exercised 373 571
Bank owned life insurance income (189) --
Increase (decrease) in cash due to changes in:
Prepaid expenses and other assets (1,155) 6
Accrued interest receivable (329) (174)
Accrued interest payable and other liabilities 1,268 (1,681)
Federal income taxes
Current 1,008 2
Deferred 964 199
- ---------------------------------------------------------------------------------------------------
Net cash provided by operating activities 13,640 10,620
CASH FLOWS USED IN INVESTING ACTIVITIES:
Loan disbursements (152,440) (205,159)
Principal repayments on loans 137,132 165,958
Principal repayments on mortgage-backed securities designated
as available for sale 8,367 9,222
Proceeds from sale of investment securities designated
as available for sale 18,891 7,628
Proceeds from maturity of investment securities 1,100 3,500
Proceeds from disposition of assets 279 --
Purchase of investment securities designated
as available-for-sale (45,614) (20,990)
Purchase of insurance agency (12) --
Purchase of other real estate owned -- (282)
Decrease in federal funds sold - net 147 38
Purchase of office premises and equipment (1,091) (912)
- ---------------------------------------------------------------------------------------------------
Lawrence Financial acquisition - net of cash paid 6,674 --
- ---------------------------------------------------------------------------------------------------
Net cash used in investing activities (26,567) (40,997)
- ---------------------------------------------------------------------------------------------------
Net cash used in operating and investing activities
(balance carried forward) (12,927) (30,377)
- ---------------------------------------------------------------------------------------------------
-6-
Oak Hill Financial, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (continued)
For the Six Months Ended
------------------------
June 30,
(In thousands) 2005 2004
- -------------------------------------------------------------------------------------------------------
Net cash used in operating and investing activities
(balance brought forward) $ (12,927) $ (30,377)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from securities sold under agreement to repurchase 13,389 1,185
Net increase (decrease) in deposit accounts (9,764) 62,069
Proceeds from Federal Home Loan Bank advances 12,500
Repayments of Federal Home Loan Bank advances (8,677) (20,328)
Repayments of notes payable (2,700) (50)
Proceeds from issuance of subordinated debenures 5,000
Dividends on common shares (1,920) (1,658)
Purchase of treasury shares (3,801) (4,369)
Proceeds from issuance of shares under stock option plan 1,259 1,533
- -------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 5,286 38,382
- -------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (7,641) 8,005
Cash and cash equivalents at beginning of period 31,009 20,390
- -------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 23,368 $ 28,395
=======================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Federal income taxes $ 744 $ 2,404
=======================================================================================================
Interest on deposits and borrowings $ 12,984 $ 9,861
=======================================================================================================
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
Unrealized gains (losses) on securities designated as available for sale,
net of related tax effects $ 117 $ (1,165)
=======================================================================================================
Recognition of mortgage servicing rights in accordance with SFAS No. 140 $ 225 $ 397
=======================================================================================================
Transfer from loans to real estate acquired through foreclosure $ 33 $ 1,293
=======================================================================================================
Loans identified as held-for-sale $ -- $ 775
=======================================================================================================
Fair value of assets acquired in acquisition of Lawrence Financial $ 125,121 $ --
=======================================================================================================
Common stock issued in acquisition of Lawrence Financial $ 8,589 $ --
=======================================================================================================
Goodwill and other intangible assets arising from acquisitions - net $ 9,162 $ --
=======================================================================================================
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Treasury shares issued for options exercised $ 2,373 $ 988
=======================================================================================================
-7-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
1. Basis of Presentation
---------------------
Oak Hill Financial, Inc. (the "Company") is a financial holding company
the principal assets of which have been its ownership of Oak Hill Banks ("Oak
Hill") and Oak Hill Financial Insurance Agency, Inc. dba MPA Group Insurance
Specialists ("MPA"). The Company also owns forty-nine percent of Oak Hill Title
Agency, LLC ("Oak Hill Title") which provides title services for commercial and
residential real estate transactions. Accordingly, the Company's results of
operations are primarily dependent upon the results of operations of its
subsidiaries.
On October 9, 2004, the Company acquired Ripley National Bank ("Ripley")
for $5.3 million in cash. As part of the transaction, the Company acquired
full-service offices in Ripley and Georgetown, Ohio, involving total loans of
$39.1 million, $51.6 million in deposits and $58.6 million in total assets.
On December 31, 2004, the Company sold the consumer loan portfolio of
Action Finance Company. The portfolio, which was comprised of small consumer and
second mortgage loans, totaled $8.7 million. Concurrent with the sale, the
Company closed its five retail lending offices in southern Ohio.
On April 1, 2005, the Company completed its previously announced merger
with Lawrence Financial Holdings, Inc. ("Lawrence Financial") for a purchase
price of approximately $15.2 million, of which $7.7 million was paid in cash. In
addition, the Company issued 221,051 shares of common stock to Lawrence
Financial shareholders. The transaction added $125.1 million in assets, $76.5
million in loans, $104.2 million in deposits and $8.6 million in equity to the
Company.
Oak Hill conducts a general commercial banking business in southern and
central Ohio which consists of attracting deposits from the general public and
applying those funds to the origination of loans for commercial, consumer and
residential purposes. MPA is an insurance agency specializing in group health
insurance and other employee benefits.
Oak Hill's profitability is significantly dependent on net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e., loans and investments) and the interest expense
paid on interest-bearing liabilities (i.e., customer deposits and borrowed
funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and the interest
received or paid on these balances. The level of interest rates paid or received
by Oak Hill can be significantly influenced by a number of competitive factors,
such as governmental monetary policy, that are outside of management's control.
The accompanying unaudited consolidated financial statements were prepared
in accordance with instructions for Form 10-Q and, therefore, do not include
information or footnotes necessary for a complete presentation of financial
position, results of operations and cash flows in conformity with accounting
principles generally accepted in the United States of America. Accordingly,
these financial statements should be read in conjunction with the consolidated
financial statements and notes thereto of the Company included in the Annual
Report on Form 10-K for the year ended December 31, 2004. However, all
adjustments (consisting of normal recurring accruals), which, in the opinion of
management, are necessary for a fair presentation of the consolidated financial
statements, have been included. The results of operations for the six and three
months ended June 30, 2005 are not necessarily indicative of the results that
may be expected for the entire year.
2. Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Oak Hill and MPA. The Company effectively
controls Oak Hill Title; therefore, its accounts are also included in the
financial statements of the Company with the remaining ownership being accounted
for as minority interest. All intercompany balances and transactions have been
eliminated.
3. Liquidity and Capital Resources
-------------------------------
Like other financial institutions, the Company must ensure that sufficient
funds are available to meet deposit withdrawals, loan commitments, and expenses.
Control of the Company's cash flow requires the anticipation of deposit flows
and loan payments. The Company's primary sources of funds are deposits,
borrowings and principal and interest payments on loans. The Company uses funds
from deposit inflows, proceeds from borrowings and principal and interest
payments on loans primarily to originate loans, and to purchase short-term
investment securities and interest-bearing deposits.
-8-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
3. Liquidity and Capital Resources (continued)
------------------------------------------
At June 30, 2005, the Company had $250.7 million of certificates of
deposit maturing within one year. It has been the Company's historic experience
that such certificates of deposit will be replaced or renewed with Oak Hill at
market rates of interest. It is management's belief that maturing certificates
of deposit over the next year will similarly be replaced or renewed with Oak
Hill at market rates of interest without a material adverse effect on the
results of operations.
In the event that certificates of deposit cannot be renewed at prevalent
market rates, the Company can obtain a maximum of $168.2 million in advances
from the Federal Home Loan Bank of Cincinnati (FHLB). Also, as an operational
philosophy, the Company seeks to obtain advances to help with asset/liability
management and liquidity. At June 30, 2005, the Company had $111.9 million of
outstanding FHLB advances.
The Company engages in off-balance sheet credit-related activities that
could require the Company to make cash payments in the event that specified
future events occur. The contractual amounts of these activities represent the
maximum exposure to the Company. However, certain off-balance sheet commitments
are expected to expire or be only partially used; therefore, the total amount of
commitments does not necessarily represent future cash requirements. These
off-balance sheet activities are necessary to meet the financing needs of the
Company's customers. At June 30, 2005, the Company had total off-balance sheet
contractual commitments consisting of $21.5 million to originate loans, or loans
committed but not closed, $115.4 million in unused lines of credit and letters
of credit totaling $15.4 million. Funding for these amounts is expected to be
provided by the sources described above. Management believes the Company has
adequate resources to meet its normal funding requirements.
The table below details the amount of loan commitments, unused lines of
credit and letters of credit outstanding at June 30, 2005, by expiration period:
One year Two to After
(In thousands) or less three years three years Total
- ------------------------------------------------------------------------------------------------------------------------
Loan commitments $ 21,543 $ -- $ -- $ 21,543
Unused lines of credit 62,994 13,881 38,572 115,447
Letters of credit 1,282 4,150 10,000 15,432
- ------------------------------------------------------------------------------------------------------------------------
$ 85,819 $ 18,031 $ 48,572 $152,422
========================================================================================================================
The table below details the amount of contractual obligations outstanding
at June 30, 2005, by expiration period:
One year Two to After
(In thousands) or less three years three years Total
- ------------------------------------------------------------------------------------------------------------------------
Advances from the Federal Home Loan Bank $ 35,721 $ 22,369 $ 53,834 $111,924
Securities sold under agreement to repurchase(1) -- -- 10,000 10,000
Subordinated debentures -- -- 23,000 23,000
Lease obligations 760 1,436 2,073 4,269
- ------------------------------------------------------------------------------------------------------------------------
$ 36,481 $ 23,805 $ 88,907 $149,193
========================================================================================================================
(1) Includes only repurchase agreements with a stated maturity.
-9-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
4. Earnings Per Share
------------------
Basic earnings per common share is computed based upon the
weighted-average number of common shares outstanding during the period. Diluted
earnings per common share is computed including the dilutive effect of
additional potential common shares issuable under stock options. The
computations were as follows for the six and three-month periods ended June 30:
For the Six Months Ended For the Three Months Ended
June 30, June 30,
2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Weighted-average common shares outstanding (basic) 5,682,908 5,554,720 5,798,175 5,527,269
Dilutive effect of assumed exercise of stock options 138,156 147,750 124,163 140,507
- ------------------------------------------------------------------------------------------------------------------
Weighted-average common shares outstanding (diluted) 5,821,064 5,702,470 5,922,338 5,667,776
==================================================================================================================
Options to purchase 122,250 shares of common stock with a weighted-average
exercise price of $37.21 were outstanding at June 30, 2005, but were excluded
from the computation of common share equivalents for the six and three month
periods ended June 30, 2005 because the exercise prices were greater than the
average market price of the common shares.
5. Critical Accounting Policies
----------------------------
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to use judgments in making estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses. The
following critical accounting policies are based upon judgments and assumptions
by management that include inherent risks and uncertainties.
Allowance for Losses on Loans: The balance in this account is an
accounting estimate of probable but unconfirmed asset impairment that has
occurred in the Company's loan portfolio as of the date of the consolidated
financial statements before losses have been confirmed resulting in a subsequent
charge-off or write-down. It is the Company's policy to provide valuation
allowances for estimated losses on loans based upon past loss experience,
adjusted for changes in trends and conditions of the certain items, including:
o Local market areas and national economic developments;
o Levels of and trends in delinquencies and impaired loans;
o Levels of and trends in recoveries of prior charge-offs;
o Adverse situations that may affect specific borrowers' ability to
repay;
o Effects of any changes in lending policies and procedures;
o Credit concentrations;
o Experience, ability, and depth of lending management and credit
administration staff;
o Volume and terms of loans; and
o Current collateral values, where appropriate.
When the collection of a loan becomes doubtful, or otherwise troubled, the
Company records a loan loss provision equal to the difference between the fair
value of the property securing the loan and the loan's carrying value. Unsecured
credits are charged-off upon becoming contractually delinquent for greater than
90 days. Major loans and major lending areas are reviewed periodically to
determine potential problems at an early date. The allowance for loan losses is
increased by charges to earnings and decreased by charge-offs (net of
recoveries).
-10-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
5. Critical Accounting Policies (continued)
---------------------------------------
The Company accounts for its allowance for losses on loans in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for
Contingencies," and SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan." Both Statements require the Company to evaluate the collectibility of
both contractual interest and principal loan payments. SFAS No. 5 requires the
accrual of a loss when it is probable that a loan has been impaired and the
amount of the loss can be reasonably estimated. SFAS No. 114 requires that
impaired loans be measured based upon the present value of expected future cash
flows discounted at the loan's effective interest rate or, as an alternative, at
the loans' observable market price or fair value of the collateral.
A loan is defined under SFAS No. 114 as impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due according to the contractual terms of the loan agreement. In
applying the provisions of SFAS No. 114, the Company considers its investment in
one-to-four family residential loans, consumer installment loans and credit card
loans to be homogeneous and therefore excluded from separate identification for
evaluation of impairment. These homogeneous loan groups are evaluated for
impairment in accordance with SFAS No. 5. With respect to the Company's
investment in commercial and other loans, and its evaluation of impairment
thereof, management believes such loans are adequately collateralized and as a
result impaired loans are carried as a practical expedient at the lower of cost
or fair value.
It is the Company's policy to charge off unsecured credits that are more
than ninety days delinquent. Similarly, collateral dependent loans which are
more than ninety days delinquent are considered to constitute more than a
minimum delay in repayment and are evaluated for impairment under SFAS No. 114
at that time.
Mortgage Servicing Rights: Mortgage servicing rights are accounted for
pursuant to the provisions of SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
requires that the Company recognize as separate assets, rights to service
mortgage loans for others, regardless of how those servicing rights are
acquired. An institution that acquires mortgage servicing rights through either
the purchase or origination of mortgage loans and sells those loans with
servicing rights retained must allocate some of the cost of the loans to the
mortgage servicing rights.
The mortgage servicing rights recorded by the Company, calculated in
accordance with the provisions of SFAS No. 140, were segregated into pools for
valuation purposes, using as pooling criteria the loan term and coupon rate.
Once pooled, each grouping of loans was evaluated on a discounted earnings basis
to determine the present value of future earnings that a purchaser could expect
to realize from each portfolio. Earnings were projected from a variety of
sources including loan servicing fees, interest earned on float, net interest
earned on escrows, miscellaneous income, and costs to service the loans. The
present value of future earnings is the "economic" value of the pool, i.e., the
net realizable present value to an acquirer of the acquired servicing.
SFAS No. 140 requires that capitalized mortgage servicing rights and
capitalized excess servicing receivables be amortized in proportion to and over
the period of estimated net servicing income and assessed for impairment.
Impairment is measured based on fair value. The valuation of mortgage servicing
rights is influenced by market factors, including servicing volumes and market
prices, as well as management's assumptions regarding mortgage prepayment speeds
and interest rates. Management utilizes periodic third-party valuations by
qualified market professionals to evaluate the fair value of its capitalized
mortgage servicing assets.
Goodwill and Other Intangible Assets. The Company has recorded goodwill
and core deposit intangibles as a result of merger and acquisition activity.
Goodwill represents the excess purchase price paid over the net book value
of the assets acquired in a merger or acquisition. Pursuant to SFAS No. 142,
"Goodwill and Intangible Assets," goodwill is not amortized, but is tested for
impairment at the reporting unit annually and whenever an impairment indicator
arises. The evaluation involves assigning assets and liabilities to reporting
units and comparing the fair value of each reporting unit to its carrying value
including goodwill. If the fair value of a reporting unit exceeds its carrying
amount, goodwill is not considered impaired. However, if the carrying amount of
the reporting unit exceeds the fair value, goodwill is considered impaired. The
impairment loss equals the excess of carrying value over fair value.
Core deposit intangibles represent the value of long-term deposit
relationships and are amortized over their estimated useful lives. The Company
annually evaluates these estimated useful lives. If the Company determines that
events or circumstances warrant a change in these estimated useful lives, the
Company will adjust the amortization of the core deposit intangibles, which
could affect future amortization expense.
-11-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
6. Stock-Based Compensation
------------------------
The Company has stock incentive plans that provide for grants of options,
restricted stock and other equity-based instruments of up to 1,200,000 of its
common stock. The Company accounts for its stock incentive plans in accordance
with SFAS No. 123, "Accounting for Stock-Based Compensation," which contains a
fair value-based method for valuing stock-based compensation that entities may
use, which measures compensation cost at the grant date based on the fair value
of the award. Compensation is then recognized over the service period, which is
usually the vesting period. Alternatively, SFAS No. 123 permits entities to
continue to account for stock options and similar equity instruments under
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." Entities that continue to account for stock options using APB
Opinion No. 25 are required to make pro forma disclosures of net earnings and
earnings per share, as if the fair value-based method of accounting defined in
SFAS No. 123 had been applied.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its stock incentive plans. Accordingly, no compensation cost has
been recognized for the plan. Had compensation cost for the Company's stock
incentive plan been determined based on the fair value at the grant dates for
awards under the plan consistent with the accounting method utilized in SFAS No.
123, the Company's net earnings and earnings per share would have been reduced
to the pro-forma amounts indicated below for the six and three months ended June
30:
For the Six Months Ended For the Three Months Ended
------------------------ --------------------------
June 30, June 30,
(In thousands, except share data) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------
Net earnings:
As reported $ 3,861 $ 6,395 $ 601 $ 3,248
Stock-based compensation, net of tax (506) (206) (253) (103)
- ------------------------------------------------------------------------------------------
Pro-forma net earnings $ 3,355 $ 6,189 $ 348 $ 3,145
==========================================================================================
Basic earnings per share:
As reported $ .68 $ 1.15 $ .10 $ .59
Stock-based compensation, net of tax (.09) (.04) (.04) (.02)
- ------------------------------------------------------------------------------------------
Pro-forma $ .59 $ 1.11 $ .06 $ .57
==========================================================================================
Diluted earnings per share:
As reported $ .66 $ 1.12 $ .10 $ .57
Stock-based compensation, net of tax (.08) (.03) (.04) (.01)
- ------------------------------------------------------------------------------------------
Pro-forma $ .58 $ 1.09 $ .06 $ .56
==========================================================================================
The fair value of each option granted is estimated on the date of grant
using the modified Black-Scholes options-pricing model with the following
weighted-average assumptions used for grants in 2005, 2004 and 2003: dividend
yield of 1.6% for 2005 and 2004 and 2.3% for 2003; expected volatility 39.8% for
2005 and 2004 and 41.5% for 2003; risk-free interest rates of 3.65% for 2005 and
2004 and 3.38% for 2003; and expected lives of 4 years for 2005, 2004 and 2003.
-12-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
6. Stock-Based Compensation (continued)
-----------------------------------
A summary of the status of the Company's stock incentive plans as of June
30, 2005 and December 31, 2004 and 2003 and changes during the periods ended on
those dates is presented below:
Six Months Ended Year Ended
June 30, December 31,
2005 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
average average average
exercise exercise exercise
Shares price Shares price Shares price
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of period 582,466 $ 22.21 572,397 $ 17.36 718,717 $ 15.35
Granted 5,000 35.20 130,500 37.19 68,000 30.46
Exercised (74,250) 16.95 (118,131) 15.87 210,820) 14.77
Forfeited (10,183) 36.64 (2,300) 28.45 (3,500) 15.05
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at end of period 503,033 $ 22.82 582,466 $ 22.21 572,397 $ 17.36
========================================================================================================================
Options exercisable at period end 497,783 451,633 503,730
========================================================================================================================
Weighted-average fair value of options granted
during the period $ 13.14 $ 12.91 $ 9.31
========================================================================================================================
The following information applies to options outstanding at June 30, 2005:
Range of exercise prices Number outstanding
- --------------------------------------------------------------------------------
$ 6.67 - $10.01 15,650
$10.02 - $15.03 39,100
$15.04 - $22.56
264,433
$22.57 - $33.86 61,600
$33.87 - $37.72 122,250
- --------------------------------------------------------------------------------
Total 503,033
================================================================================
Weighted-average exercise price $22.82
Weighted-average remaining contractual life 7.8 years
7. Effects of Recent Accounting Pronouncements
-------------------------------------------
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued a revised Statement of Financial Accounting Standard ("SFAS") No. 123(R),
"Share-Based Payment," which establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services, primarily on accounting for transactions in which an entity obtains
employee services in share-based transactions. This Statement requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award,
with limited exceptions. That cost will be recognized over the period during
which an employee is required to provide services in exchange for the award, the
requisite service period. No compensation cost is recognized for equity
instruments for which employees do not render the requisite service. Employee
share purchase plans will not result in recognition of compensation cost if
certain conditions are met.
Initially, the cost of employee services received in exchange for an award
of liability instruments will be measured based on current fair value; the fair
value of that award will be remeasured subsequently at each reporting date
through the settlement date.
-13-
Oak Hill Financial, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended June 30, 2005 and 2004
7. Effects of Recent Accounting Pronouncements (continued)
------------------------------------------------------
Changes in fair value during the requisite service period will be recognized as
compensation cost over that period. The grant-date fair value of employee share
options and similar instruments will be estimated using option-pricing models
adjusted for the unique characteristics of those instruments (unless observable
market prices for the same or similar instruments are available). If an equity
award is modified after the grant date, incremental compensation cost will be
recognized in an amount equal to the excess of the fair value of the modified
award over the fair value of the original award immediately before the
modification.
Excess tax benefits, as defined by SFAS 123R, will be recognized as an
addition to additional paid in capital. Cash retained as a result of those
excess tax benefits will be presented in the statement of cash flows as
financing cash inflows. The write-off of deferred tax assets relating to
unrealized tax benefits associated with recognized compensation cost will be
recognized as income tax expense unless there are excess tax benefits from
previous awards remaining in additional paid in capital to which it can be
offset.
Effective April 2005, compensation cost is required to be recognized
beginning as of the first annual period of the fiscal year that begins on or
after June 15, 2005, or January 1, 2006 as to the Company. Management believes
the quarterly and six month compensation costs, net of tax, will approximate the
pro forma amounts disclosed above.
-14-
Forward-Looking Statements
This report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations, contains forward-looking statements about
the Company. These forward-looking statements include statements regarding
financial condition, results of operations, plans, objectives, and the future
performance and business of the Company, including management's establishment of
an allowance for loan losses, its statements regarding the adequacy of such
allowance for loan losses, and management's belief that the allowance for loan
losses is adequate. Forward-looking statements can be identified by the fact
that they do not relate strictly to historical or current facts.
By their nature, forward-looking statements are subject to numerous assumptions,
risks, and uncertainties. A number of factors could cause actual conditions,
events, or results to differ significantly and materially from those described
in the forward-looking statements. These factors include, but are not limited
to, those set forth below and under the heading "Business Risks" included in
Item 1 of the Company's Annual Report on Form 10-K for the year ended December
31, 2004 (2004 Form 10-K), and other factors described in the 2004 Form 10-K,
and from time-to-time in other filings with the Securities and Exchange
Commission.
Forward-looking statements speak only as of the date they are made. The Company
assumes no obligation to update forward-looking statements to reflect
circumstances or events that occur after the date the forward-looking statements
were made or to reflect the occurrence of unanticipated events.
Risk Factors
Oak Hill Financial, like other financial companies, is subject to a number of
risks, many of which are outside of management's control. Management strives to
mitigate those risks while optimizing returns. Among the risks assumed are: (1)
credit risk, which is the risk that loan and lease customers or other counter
parties will be unable to perform their contractual obligations, (2) market
risk, which is the risk that changes in market rates and prices will adversely
affect the Company's financial condition or results of operations, (3) liquidity
risk, which is the risk that the Company will have insufficient cash or access
to cash to meet operating needs, and (4) operational risk, which is the risk of
loss resulting from inadequate or failed internal processes, people, or systems,
or external events, and (5) legal risk, which is the risk of legal proceedings
against the Company as well as regulatory and governmental reviews or
investigations that arise in the course of the Company's business. The
description of the Company's business contained in Item 1 of its 2004 Form 10-K,
while not all inclusive, discusses a number of business risks that, in addition
to the other information in this report, readers should carefully consider.
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Oak Hill Financial, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the six and three month periods ended June 30, 2005 and 2004
Discussion of Financial Condition Changes from December 31, 2004 to June 30,
- --------------------------------------------------------------------------------
2005
- ----
The Company's total assets amounted to $1.2 billion as of June 30, 2005,
an increase of $128.2 million, or 11.8%, over the total at December 31, 2004.
The increase in assets was funded primarily through the assumption of $104.2
million of deposits in the Lawrence Financial transaction, a $13.4 million
increase in repurchase agreements, an increase in FHLB advances of $6.3 million
and a $5.0 million increase in subordinated debentures, which were partially
offset by a $2.7 million decrease in notes payable.
Cash and due from banks, federal funds sold, and investment securities,
including mortgage-backed securities, increased by $25.6 million, or 20.6%, to a
total of $149.6 million at June 30, 2005, compared to December 31, 2004.
Investment securities increased by $33.4 million, as purchases of $45.6 million
and $15.5 million of securities acquired in the Lawrence Financial transaction
exceeded maturities and repayments of $9.5 million and sales of $18.5 million.
Federal funds sold decreased by $147,000 during the six-month period ended June
30, 2005.
Loans receivable, including loans held for sale, totaled $997.9 million,
including $77.1 million acquired in the Lawrence Financial transaction, at June
30, 2005, an increase of $85.3 million, or 9.4%, over the comparable totals at
December 31, 2004. Loan disbursements totaled $169.6 million during the
six-month period ended June 30, 2005, which were partially offset by loan sales
of $17.4 million and principal repayments of $137.1 million. Loan disbursements
and sales volume decreased by $64.2 million and $13.4 million, respectively, as
compared to the same period in 2004. Loan originations and sales volume declined
primarily due to the decrease in origination and sales of residential real
estate loans in the secondary market. Growth in the loan portfolio during the
six months ended June 30, 2005 was comprised of a $66.4 million, or 10.8%,
increase in commercial and residential real estate loans and a $34.4 million, or
50.5%, increase in installment loans, which were partially offset by a $13.9
million, or 5.9%, decrease in commercial and other loans, and a $50,000, or
2.5%, decrease in credit card loans. The Company's allowance for loan losses
totaled
-15-
Oak Hill Financial, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the six and three month periods ended June 30, 2005 and 2004
$13.4 million at June 30, 2005, an increase of $1.5 million, or 13.0%, over the
total at December 31, 2004. The allowance for loan losses represented 1.32% and
1.28% of the total loan portfolio at June 30, 2005 and December 31, 2004,
respectively. Net charge-offs totaled approximately $3.9 million and $844,000
for the six months ended June 30, 2005 and 2004, respectively. The Company's
allowance represented 75.3% and 186.8% of nonperforming loans, which totaled
$17.8 million and $6.3 million at June 30, 2005 and December 31, 2004,
respectively. At June 30, 2005, nonperforming loans were comprised of $552,000
in installment loans, $4.7 million in commercial and other loans, $9.4 million
of loans secured primarily by commercial real estate and $3.1 million of loans
secured by one-to-four family residential real estate. In management's opinion,
all nonperforming loans were adequately collateralized or reserved for at June
30, 2005.
The preponderance of the Company's $11.5 million increase in nonperforming
loan totals was attributable to three loan concentrations with an aggregate
carrying value of $9.2 million at June 30, 2005. In the case of each
concentration, management became aware of deterioration in credit quality during
the second quarter of 2005 and accordingly effected write-downs of $2.5 million
to reduce the attendant loans to fair value at June 30, 2005. In addition during
the second quarter of 2005, the Company increased the provision and related
allowance by $1.1 million as a result of management's ongoing review and
monitoring of the loan portfolio. Finally, management added approximately
$400,000 to the allowance relative to an increased risk coefficient of portfolio
loss relative to management's assessment of economic conditions.
Deposits totaled $958.3 million at June 30, 2005, an increase of $96.2
million, or 11.2%, from the total at December 31, 2004. Such increase was
primarily attributable to the assumption of $104.2 million in deposits in the
Lawrence Financial transaction. Brokered deposits continued to be an integral
part of the Company's overall funding strategy due to competitive rates and
lower operational costs compared with retail deposits. Brokered deposits totaled
$100.6 million with a weighted-average cost of 3.12% at June 30, 2005, as
compared to the $113.1 million in brokered deposits with a 2.70%
weighted-average cost at December 31, 2004.
Advances from the Federal Home Loan Bank totaled $111.9 million at June
30, 2005, an increase of $6.3 million, or 6.0%, over the total at December 31,
2004. Securities sold under agreements to repurchase totaled $18.7 million at
June 30, 2005, an increase of $13.4 million, over the total at December 31,
2004. The increase resulted primarily from $10.0 million in reverse repurchase
agreements incepted in March 2005. Notes payable decreased $2.7 million as the
Company repaid a note to another financial institution.
In June 2005, a Delaware statutory trust owned by the Company, Oak Hill
Capital Trust 4 ("Trust 4"), issued $5.0 million of mandatorily redeemable debt
securities. The debt securities issued by Trust 4 are included in the Company's
regulatory capital, specifically as a component of Tier 1 capital. The proceeds
from the issuance of the subordinated debentures and common securities were used
by Trust 4 to purchase from the Company $5.0 million of subordinated debentures
maturing on June 30, 2035. The subordinated debentures are the sole asset of
Trust 4, and the Company owns all of the common securities of Trust 4. Interest
payments on the debt securities are to be made quarterly at an annual fixed rate
of interest of 5.96% through June 30, 2015 and at a floating rate of interest,
reset quarterly, equal to 3-month LIBOR plus 1.60% thereafter. Interest payments
are reported as a component of interest expense on borrowings. The net proceeds
received by the Company were contributed to the capital of Oak Hill during the
quarter ended June 30, 2005.
The Company's stockholders' equity amounted to $93.5 million at June 30,
2005, an increase of $8.5 million, or 10.0%, over the balance at December 31,
2004. The increase resulted primarily from net earnings of $3.9 million,
proceeds from options exercised of $1.6 million, a $117,000 increase in the
unrealized gain on securities to an overall unrealized gain of $722,000 at June
30, 2005 and $8.3 million in stockholders' equity through issuance of shares in
the Lawrence Financial transaction, which were partially offset by $1.9 million
in dividends declared on common stock and the Company's repurchase of 136,651
outstanding shares of its common stock at a weighted-average price of $27.82 per
share totaling $3.8 million.
Comparison of Results of Operations for the Six-Month Periods Ended June 30,
- --------------------------------------------------------------------------------
2005 and 2004
- -------------
General
- -------
Net earnings for the six months ended June 30, 2005 totaled $3.9 million,
a $2.5 million, or 39.6%, decrease from the net earnings reported in the
comparable 2004 period. The decrease in earnings resulted primarily from a $4.2
million increase in the provision for losses on loans and a $1.9 million
increase in general, administrative and other expense, which were partially
offset by a $986,000 increase in net interest income, a $427,000 increase in
other income, and a $2.1 million decrease in the provision for federal income
taxes.
-16-
Oak Hill Financial, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the six and three month periods ended June 30, 2005 and 2004
Net Interest Income
- -------------------
Total interest income for the six months ended June 30, 2005, amounted to
$32.9 million, an increase of $4.3 million, or 15.1%, over the comparable 2004
period. Interest income on loans totaled $30.4 million, an increase of $3.6
million, or 13.4%, over the 2004 period. This increase resulted primarily from a
$129.0 million, or 15.3%, increase in the weighted-average ("average") portfolio
balance, to a total of $970.1 million for the six months ended June 30, 2005,
which was partially offset by a 9 basis point decrease in the average
fully-taxable equivalent yield, to 6.34% for the six month period ended June 30,
2005. Interest income on investment securities and other interest-earning assets
increased by $719,000, or 41.7%. The increase resulted primarily from a $28.8
million, or 31.7%, increase in the average portfolio balance, to a total of
$119.6 million for the six months ended June 30, 2005, coupled with a 62 basis
point increase in the average fully-taxable equivalent yield, to 4.88% for the
six months ended June 30, 2005.
Total interest expense amounted to $13.2 million for the six months ended
June 30, 2005, an increase of $3.3 million, or 33.6%, over the comparable 2004
period. Interest expense on deposits increased by $2.7 million, or 36.1%, to a
total of $10.2 million for the six months ended June 30, 2005. The increase
resulted primarily from a 28 basis point increase in the average cost of
deposits, to 2.28% for the six months ended June 30, 2005, coupled with a $150.3
million, or 19.8%, increase in the average portfolio balance, to a total of
$908.4 million for the six months ended June 30, 2005. Interest expense on
borrowings increased by $603,000, or 25.7%, for the six months ended June 30,
2005. The increase was due to a $22.6 million, or 19.0%, increase in the average
borrowings outstanding for the six months ended June 30, 2005, coupled with a 23
basis point increase in the average cost of borrowings, to 4.20%. The increase
in the level of yields on interest-earning assets and the cost of
interest-bearing liabilities was primarily due to the rising interest rate
environment for the six month period ended June 30, 2005. Specifically, the
Federal Reserve Board has increased its interbank borrowing rates nine times
over the last year and has again recently indicated its continuing bias towards
future rate increases. While management believes its asset/liability management
strategy serves to mitigate the negative effects of rising interest rates,
current and projected increases in short-term interest rates will continue to
pressure the Company's net interest margin through the remainder of 2005.
As a result of the foregoing changes in interest income and interest
expense, net interest income increased by $986,000, or 5.3%, for the six months
ended June 30, 2005, as compared to the same period in 2004. The interest rate
spread decreased by 30 basis points, to 3.65% for the six months ended June 30,
2005, compared to 3.95% for the six months ended June 30, 2004. The
fully-taxable equivalent net interest margin decreased by 35 basis points from,
4.09% to 3.74% for the six months ended June 30, 2004 and 2005, respectively.
Provision for Losses on Loans
- -----------------------------
A provision for losses on loans is charged to earnings to bring the total
allowance for loan losses to a level considered appropriate by management based
on historical experience, the volume and type of lending conducted by the
Company, the status of past due principal and interest payments, general
economic conditions, particularly as such conditions relate to the Company's
market area and other factors related to the collectibility of the Company's
loan portfolio. As a result of such analysis, which was discussed in detail
above, management recorded a $5.5 million provision for losses on loans for the
six months ended June 30, 2005, an increase of $4.2 million, compared to same
period in 2004. The provision for losses on loans for the six months ended June
30, 2005 was predicated primarily upon the $86.8 million of growth in the gross
loan portfolio, the $4.4 million of loans charged-off during the current period,
and an increase in nonperforming loans from $6.3 million at December 31, 2004 to
$17.8 million at June 30, 2005.
Consistent with the Company's policy for determining the adequacy of its
allowance for loan losses, management continues to closely monitor criticized
loans for, among other factors previously discussed, adverse situations
affecting borrowers' abilities to repay and an assessment of current collateral
values. Although management believes that it uses the best information available
in providing for possible loan losses, future adjustments to the allowance could
be necessary and net earnings could be adversely affected.
Other Income
- ------------
Other income totaled $5.5 million for the six months ended June 30, 2005,
an increase of $427,000, or 8.3%, over the amount reported in the comparable
2004 period. This increase resulted primarily from a $768,000, or 30.7%,
increase in service fees and charges and a $168,000, or 83.2%, increase in gain
on sale of securities, which were partially offset by a $151,000, or 10.0%,
decrease in insurance commissions and a $358,000, or 39.8%, decrease in gain on
sale of loans. The increase in service fees, charges and other income was due
primarily to an increase in ATM fees totaling $205,000 and an increase in bank
owned life insurance income of $189,000 for the six months ended June 30, 2005.
The gain on sale of loans decrease is attributable to a $96,000 decrease in
gains from the sale of Small Business Administration loans, coupled with a
$262,000 decrease in gains from the sale of residential real estate loans.
-17-
Oak Hill Financial, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the six and three month periods ended June 30, 2005 and 2004
General, Administrative and Other Expense
- -----------------------------------------
General, administrative and other expense totaled $14.8 million for the
six months ended June 30, 2005, an increase of $1.9 million, or 14.5%, over the
amount reported in the 2004 period. The increase resulted primarily from a $1.3
million, or 35.8%, increase in other operating expenses including merger-related
expenses and amortization of the core deposit intangible, a $433,000, or 26.7%,
increase in occupancy and equipment, and a $498,000, or 7.0%, increase in
compensation and benefits, which were partially offset by a $386,000, or 78.9%,
decrease in franchise tax expense.
The increase in occupancy and equipment expense was due primarily to a
$262,000, or 49.5%, increase in maintenance and maintenance contracts and a
$168,000, or 32.9%, increase in depreciation expense. The increase in other
expenses resulted primarily from a $371,000 increase in amortization of core
deposit intangible, a $111,000, or 27.4%, increase in professional fees, a
$94,000, or 50.0%, increase in ATM expenses, a $32,000, or 20.5%, increase in
travel expense, a $71,000, or 36.1%, increase in postage, a $453,000 increase in
merger-related expenses, a $93,000 increase in marketing expenses, coupled with
incremental increases in other operating expenses year-to-year. The increase in
compensation and benefits resulted primarily from a $223,000, or 3.3%, increase
in salaries and wages partially attributable to yearly salary increases, an
$85,000, or 23.1%, increase in group insurance, an $86,000, or 52.3%, increase
in retirement expense and a $17,000, or 25.9%, increase in directors' fees. The
decrease in franchise tax expense generally reflects tax savings as a result of
the Ripley acquisition.
Federal Income Taxes
- --------------------
The provision for federal income taxes amounted to $1.1 million for the
six months ended June 30, 2005, a decrease of $2.1 million, or 65.6%, from the
comparable 2004 period. The decrease resulted primarily from a $4.6 million, or
48.3%, decrease in earnings before taxes, coupled with $250,000 in new markets
tax credits related to the Bank's investment in Oak Hill Community Development
Corp. The effective tax rates were 22.2% and 33.4% for the six months ended June
30, 2005 and 2004, respectively.
Comparison of Results of Operations for the Three-Month Periods Ended June 30,
- --------------------------------------------------------------------------------
2005 and 2004
- -------------
General
- -------
Net earnings for the three months ended June 30, 2005 totaled $601,000, a
$2.6 million, or 81.5%, decrease from the net earnings reported in the
comparable 2004 period. The decrease in earnings resulted primarily from a $4.0
million increase in the provision for losses on loans and a $1.3 million
increase in a general, administrative and other expense, which were partially
offset by a $578,000 increase in net interest income, a $240,000 increase in
other income, and a $1.8 million decrease in the provision for federal income
taxes.
Net Interest Income
Total interest income for the three months ended June 30, 2005, amounted
to $17.1 million, an increase of $2.7 million, or 18.9%, over the comparable
2004 period. Interest income on loans totaled $15.7 million, an increase of $2.1
million, or 15.8%, over the 2004 period. This increase resulted primarily from a
$157.8 million, or 18.5%, increase in the weighted-average ("average") portfolio
balance, to a total of $1.0 billion for the three months ended June 30, 2005,
which was partially offset by a 16 basis point decrease in the average
fully-taxable equivalent yield to 6.24% for the three month period ended June
30, 2005. Interest income on investment securities and other interest-earning
assets increased by $571,000, or 68.5%. The increase resulted primarily from a
$44.2 million, or 48.5%, increase in the average portfolio balance, to a total
of $135.2 million for the three months ended June 30, 2005, coupled with a 46
basis point increase in the average fully-taxable equivalent yield to 2.52% for
the three months ended June 30, 2005.
Total interest expense amounted to $7.1 million for the three months ended
June 30, 2005, an increase of $2.1 million, or 43.1%, over the comparable 2004
period. Interest expense on deposits increased by $1.7 million, or 45.3%, to a
total of $5.5 million for the three months ended June 30, 2005. The increase
resulted primarily from a 34 basis point increase in the average cost of
deposits, to 2.31% for the three months ended June 30, 2005, coupled with a
$186.1 million, or 24.0%, increase in the average portfolio balance, to a total
of $962.7 million for the three months ended June 30, 2005. Interest expense on
borrowings increased by $410,000, or 35.5%, for the three months ended June 30,
2005. The increase was due to a $32.1 million, or 28.3%, increase in the average
borrowings outstanding for the three months ended June 30, 2005, coupled with a
22 basis point increase in the average cost of borrowings, to 4.32%. The
increase in the level of yields on interest-earning assets and the cost of
interest-bearing liabilities was primarily due to the rising interest rate
environment for the three month period ended June 30, 2005.
-18-
Oak Hill Financial, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the six and three month periods ended June 30, 2005 and 2004
As a result of the foregoing changes in interest income and interest
expense, net interest income increased by $578,000, or 6.1%, for the three
months ended June 30, 2005, as compared to the same period in 2004. The interest
rate spread decreased by 40 basis points to 3.53% for the three months ended
June 30, 2005, compared to 3.93% for the three months ended June 30, 2004. The
fully-taxable equivalent net interest margin decreased by 45 basis points from
4.06% to 3.61% for the three months ended June 30, 2004 and 2005, respectively.
Provision for Losses on Loans
- -----------------------------
A provision for losses on loans is charged to earnings to bring the total
allowance for loan losses to a level considered appropriate by management based
on historical experience, the volume and type of lending conducted by the
Company, the status of past due principal and interest payments, general
economic conditions, particularly as such conditions relate to the Company's
market area and other factors related to the collectibility of the Company's
loan portfolio. As a result of such analysis, management recorded a $4.7 million
provision for losses on loans for the three months ended June 30, 2005, an
increase of $4.0 million, compared to same period in 2004. The provision for
losses on loans for the three months ended June 30, 2005 was predicated
primarily upon the $72.6 million of growth in the gross loan portfolio, the $3.9
million of loans charged-off during the current period, and an increase in
nonperforming loans from $7.7 million at March 31, 2005 to $17.8 million at June
30, 2005.
Consistent with the Company's policy for determining the adequacy of its
allowance for loan losses, management continues to closely monitor criticized
loans for, among other factors previously discussed, adverse situations
affecting borrowers' abilities to repay and an assessment of current collateral
values. Although management believes that it uses the best information available
in providing for possible loan losses, future adjustments to the allowance could
be necessary and net earnings could be adversely affected.
Other Income
- ------------
Other income totaled $3.0 million for the three months ended June 30,
2005, an increase of $240,000, or 8.7%, over the amount reported in the
comparable 2004 period. This increase resulted primarily from a $547,000, or
41.6%, increase in service fees and charges and a $159,000 increase in gain on
sale of securities, which were partially offset by an $85,000, or 11.0%,
decrease in insurance commissions and a $381,000, or 63.0%, decrease in gain on
sale of loans. The increase in service fees, charges and other income was due
primarily to an increase in ATM fees totaling $106,000 and an increase in bank
owned life insurance income of $110,000 for the three months ended June 30,
2005. The reduction of gain on sale of loans is attributable to a $174,000
decrease in gains from the sale of Small Business Administration loans, coupled
with a $207,000 decrease in gains from the sale of residential real estate
loans.
General, Administrative and Other Expense
- -----------------------------------------
General, administrative and other expense totaled $7.9 million for the
three months ended June 30, 2005, an increase of $1.3 million, or 19.8%, over
the amount reported in the 2004 period. The increase resulted primarily from an
$880,000, or 46.5%, increase in other operating expenses including
merger-related expenses and amortization of the core deposit intangible, a
$264,000, or 33.5%, increase in occupancy and equipment, and a $356,000, or
9.8%, increase in compensation and benefits, which were partially offset by a
$195,000, or 79.6%, decrease in franchise tax expense.
The increase in occupancy and equipment expense was due primarily to a
$118,000, or 54.2%, increase in maintenance and maintenance contracts and a
$107,000, or 40.6%, increase in depreciation expense. The increase in other
expenses resulted primarily from a $299,000 increase in amortization of core
deposit intangible, a $55,000, or 24.4%, increase in professional fees, a
$65,000, or 70.2%, increase in ATM expenses, a $10,000, or 11.0%, increase in
travel expense, a $62,000 increase in postage, a $136,000 increase in
merger-related expenses, a $120,000 increase in marketing expenses, coupled with
incremental increases in other operating expenses year-to-year. The increase in
compensation and benefits resulted primarily from a $179,000, or 5.0%, increase
in salaries and wages partially attributable to yearly salary increases, a
$57,000, or 30.4%, increase in group insurance, and an $83,000 increase in
retirement expense. The decrease in franchise tax expense generally reflects a
tax savings resulting from the Ripley acquisition.
Federal Income Taxes
- --------------------
The provision for federal income taxes amounted to a benefit of $219,000
for the three months ended June 30, 2005, a decrease of $1.8 million, from the
comparable 2004 period. The decrease resulted primarily from a $4.5 million, or
92.2%, decrease in earnings before taxes, coupled with $125,000 in new markets
tax credits pursuant to the Bank's investment in Oak Hill Community Development
Corp. The effective tax (benefit) rates were (57.3)% and 33.3% for the three
months ended June 30, 2005 and 2004, respectively.
-19-
Item 3: Quantitative and Qualitative Disclosure About Market Risk
---------------------------------------------------------
There has been no significant change from disclosures included in the
Company's Annual Report on Form 10-K for the year ended December 31,
2004.
Item 4: Controls and Procedures
-----------------------
Disclosure Controls and Procedures
----------------------------------
Disclosure controls and procedures are controls and other procedures
that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the
Securities Act of 1934, as amended (the "Exchange Act") is recorded,
processed, summarized and reported, within the time periods specified
in the SEC's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure
that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and
communicated to the Company's management as appropriate to allow timely
decisions regarding required disclosure.
At the end of the period covered by this report, the Company's
management, with the participation of its chief executive officer and
chief financial officer, carried out an evaluation of the effectiveness
of our disclosure controls and procedures pursuant to Rule 13a-15
promulgated under the Exchange Act. Based upon this evaluation and the
material weaknesses in the Company's internal controls discussed below,
the Company's chief executive officer and chief financial officer
concluded that the Company's disclosure controls and procedures were
ineffective at June 30, 2005.
Internal Controls
-----------------
Management is also responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The
Company recently identified deficiencies in its internal control over
financial reporting, based on an evaluation of the effectiveness of
internal control over financial reporting. The identified material
weaknesses relate to incomplete documentation on loan and wire transfer
approvals.
Changes in Internal Control Over Financial Reporting
----------------------------------------------------
There were no changes in the Company's internal control over financial
reporting made during the quarter ended June 30, 2005, that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
-20-
PART II - OTHER INFORMATION
Item 1: Legal Proceedings
-----------------
Not applicable.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
Issuer Repurchase of Equity Securities
- -------------------------------------------------------------------------------------------------------------------------
Total Number of Maximum Number
Shares Purchased of Shares that May
As Part of Publicly Yet be Purchased
Total Number of Average Price Announced Plans Under the Plans
Period Shares Purchased Paid Per Share or Programs or Programs(1)(2)
- -------------------------------------------------------------------------------------------------------------------------
April 1, 2005 -
April 30, 2005 12,000 $30.60 12,000 153,064
- -------------------------------------------------------------------------------------------------------------------------
May 1, 2005 -
May 31, 2005 20,000 $25.96 20,000 290,000
- -------------------------------------------------------------------------------------------------------------------------
June 1, 2005 -
June 30, 2005 104,651 $27.84 104,651 185,349
- -------------------------------------------------------------------------------------------------------------------------
(1) On February 26, 2004, the Company announced that its Board of Directors
had authorized management to repurchase up to 300,000 shares of the
Company's common stock through open market or privately negotiated
transactions. The authorization did not have an expiration date.
(2) On May 26, 2005, the Company rescinded the repurchase program announced on
February 26, 2004 and announced that its Board of Directors had authorized
management to repurchase up to 290,000 shares of the Company's common
stock through open market or privately negotiated transactions. The
authorization does not have an expiration date.
Item 3: Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4: Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) The Company had its 2005 Annual Meeting of Shareholders
("Annual Meeting") on April 12, 2005. Holders of
4,930,264 common shares of the Company were present, in
person or by proxy, representing 88.6% of the Company's
5,564,904 common shares outstanding.
(b) and (c) The following persons were elected Class I members of
the Company's Board of Directors to serve until the 2007
Annual Meeting or until their successors are duly
elected and qualified. Each person received the number
of votes indicated below:
Name Votes For Votes Withheld
---- --------- --------------
R. E. Coffman, Jr. 4,525,208 405,056
John D. Kidd 4,684,954 245,310
D. Bruce Knox 4,679,395 250,869
Neil S. Strawser 4,585,463 344,801
-21-
PART II - OTHER INFORMATION (continued)
Item 4: Submission of Matters to a Vote of Security Holders (continued)
---------------------------------------------------------------
(b) and (c) The continuing Class II Directors, whose terms expire at
the 2006 Annual Meeting, are Candice R. De-Clark-Peace,
Barry M. Dorsey, Ed.D., Donald R. Seigneur, William S.
Siders, H. Grant Stephenson and Donald P Wood.
The proposal for ratification of the appointment of
Grant Thornton LLP as independent registered public
accounting firm for the Company for the year ending
December 31, 2005, was approved with 4,915,138 votes
FOR, 12,571 votes AGAINST and 2,555 votes ABSTAIN.
Item 5: Other Information
-----------------
Not applicable.
Item 6: Exhibits
--------
Exhibits:
Exhibit Number Description
-------------- -----------
31.1 Certification of Chief Executive Officer, R. E.
Coffman, Jr., dated August 8, 2005, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
("SOX").
31.2 Certification of Chief Financial Officer, Ron J.
Copher, dated August 8, 2005, pursuant to Section
302 of SOX.
32.1 Certification by Chief Executive Officer, R. E.
Coffman, Jr., dated August 8, 2005, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of SOX. -
32.2 Certification by Chief Financial Officer, Ron J.
Copher, dated August 8, 2005, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. -
-22-
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Oak Hill Financial, Inc.
Date: August 8, 2005 By: /s/ R. E. Coffman, Jr,
-----------------------------------
R. E. Coffman, Jr.
President & Chief Executive Officer
Date: August 8, 2005 By: /s/ Ron J. Copher
-----------------------------------
Ron J. Copher
Chief Financial Officer
-23-