[To be used in connection with Syndicated Community Offering only]
Pursuant to Rule 424(b)(3)
Registration No. 333-87397
PROSPECTUS SUPPLEMENT FOR SYNDICATED COMMUNITY OFFERING
[LOGO] SECURITY FINANCIAL BANCORP, INC.
(Proposed Holding Company for Security Federal Bank & Trust)
9321 Wicker Avenue
St. John, Indiana 46373
(219) 365-4344
================================================================================
Security Federal Bank, a Federal Savings Bank is converting from the mutual
to stock form of organization. After the conversion, Security Financial will
own all of Security Federal's stock. Security Financial has already received
subscriptions for _________ shares. Up to ________ shares will be sold in the
conversion. The conversion will not be completed and no common stock will be
sold unless additional subscriptions are received for at least the minimum
number of shares in the offering. Security Financial will hold all funds of
subscribers in an interest-bearing savings account at Security Federal until the
conversion is completed or terminated. Funds will be returned promptly with
interest if the conversion is terminated.
Charles Webb & Company, A Division of Keefe, Bruyette & Woods, Inc. will
use its best efforts to assist Security Financial in selling at least the
minimum number of shares but does not guarantee that this number will be sold.
Neither KBW nor any selected broker-dealer is obligated to purchase any shares
of common stock in the syndicated community offering. KBW intends to make a
market in the common stock.
================================================================================
PRICE PER SHARE: $10.00
EXPECTED TRADING MARKET AND SYMBOL: Nasdaq SmallCap Market "SFBI"
This offering will expire no later than 12:00 noon, Central time, on
____________, 1999, unless extended.
. Number of Shares
Minimum/Maximum
. Estimated Underwriting Commissions and Other Expenses
Minimum/Maximum
. Estimated Net Offering Proceeds to Security Financial
Minimum/Maximum
. Estimated Net Offering Proceeds per Share to Security Financial
Minimum/Maximum
Please refer to "Risk Factors" beginning on page __ of the attached Prospectus
dated ________ __, 1999.
These securities are not deposits or accounts and are not insured or guaranteed
by Security Financial, Security Federal, the Federal Deposit Insurance
Corporation or any other government agency. The common stock is subject to
investment risk, including the possible loss of money invested.
Neither the Securities and Exchange Commission, the Federal Deposit Insurance
Corporation, the Office of Thrift Supervision, nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus supplement is truthful or complete. Any representations to the
contrary is a criminal offense.
Charles Webb & Company, A Division of Keefe, Bruyette & Woods, Inc.
The date of this Prospectus Supplement is _______________, 1999
THE SYNDICATED COMMUNITY OFFERING
Security Financial is offering for sale between ___________ and __________
shares of common stock at price of $10.00 per share in a syndicated community
offering. These shares are to be sold in connection with the conversion of
Security Federal from a mutual savings bank to a stock savings bank and the
issuance of Security Federal outstanding capital stock to Security Financial.
The remaining __________ shares of common stock to be sold in connection with
the conversion have been subscribed for in subscription and direct community
offerings. The prospectus in the form used in the subscription and direct
community offerings is attached to this prospectus supplement. The purchase
price for all shares sold in the syndicated community offering will be the same
as the price paid by subscribers in the subscription and direct community
offerings.
Funds sent with purchase orders will earn interest at Security Federal's
passbook rate from the date Security Federal receives them until the completion
or termination of the conversion. If the syndicated community offering is not
completed by _________________, 1999, and the Office of Thrift Supervision
allows more time to complete the conversion, Security Federal will contact
everyone who subscribed for shares to see if they still want to purchase stock,
and subscribers will be able to confirm, modify or cancel their subscriptions. A
failure to respond will be treated as a cancellation of the purchase order. If
payment for the stock was made by check or money order, subscription funds will
be returned with accrued interest. If payment was authorized by withdrawal of
funds on deposit at Security Federal, that authorization would terminate. The
conversion must be completed by August 3, 2001.
The minimum number of shares which may be purchased is 25 shares. Except for the
Security Federal employee stock ownership plan, which intends to purchase up to
8% of the total number of shares of common stock sold in the conversion, no
person, together with related persons and persons acting together, may purchase
more than $200,000 of common stock (20,000 shares) in the syndicated community
offering. However, the maximum amount of shares of common stock that may be
subscribed for or purchased in all categories of the conversion by any person,
related persons or persons acting together is $400,000 of common stock (40,000
shares) sold in the conversion. Security Financial reserves the right, in its
absolute discretion, to accept or reject, in whole or in part, any or all
subscriptions in the syndicated community offering. If a subscription is
rejected in part, you cannot cancel the remainder of your order.
Security Financial and Security Federal have engaged Charles Webb &
Company, A Division of Keefe, Bruyette & Woods, Inc. as their financial advisor
to assist them in the sale of the common stock in the syndicated community
offering. KBW expects to use the services of other registered broker-dealers and
that fees to KBW and other selected broker-dealers will not exceed __% of the
aggregate purchase price of the shares sold in the syndicated community
offering.
Before this offering, there has not been a public market for the common
stock, and there can be no assurance that an active and liquid trading market
for the common stock will develop. The absence or discontinuance of an active
and liquid trading market may hurt the market price of the common stock. See
"Risk Factors--Security Financial cannot assure or guarantee an active trading
market for the common stock." in the attached prospectus.
2
Interests in
Security Federal Bank, a Federal Savings Bank
401(k) Plan
and
Offering of 142,945 Shares of
Security Financial Bancorp, Inc.
Common Stock ($.01 Par Value)
This prospectus supplement relates to the offer and sale to participants in
the Security Federal Bank, a Federal Savings Bank 401(k) Plan of participation
interests and shares of common stock of Security Financial Bancorp, Inc.
The Board of Directors of Security Federal has adopted a plan that will
convert the structure of Security Federal from a mutual savings institution to a
stock savings institution. As part of the conversion, Security Financial
Bancorp, Inc. has been established to acquire all of the stock of Security
Federal and simultaneously offer Security Financial common stock to the public
under certain purchase priorities in the plan of conversion. 401(k) Plan
participants are now permitted to direct the trustee of the 401(k) Plan to use
their current account balances to subscribe for and purchase shares of Security
Financial common stock through the Security Financial Stock Fund. Based upon
the value of the 401(k) Plan assets at August 31, 1999, the trustee of the
401(k) Plan could purchase up to 142,945 shares of Security Financial common
stock assuming a purchase price of $10.00 per share. This prospectus supplement
relates to the election of 401(k) Plan participants to direct the trustee of the
401(k) Plan to invest all or a portion of their 401(k) Plan accounts in Security
Financial common stock.
The prospectus dated November 10, 1999, of Security Financial, which we
have attached to this prospectus supplement, includes detailed information
regarding the conversion of Security Federal, Security Financial common stock
and the financial condition, results of operations and business of Security
Federal. This prospectus supplement provides information regarding the 401(k)
Plan. You should read this prospectus supplement together with the prospectus
and keep both for future reference.
Please refer to "Risk Factors" beginning on page 9 of the prospectus.
Neither the Securities and Exchange Commission, the Office of Thrift
Supervision, the Federal Deposit Insurance Corporation, nor any other state
or federal agency or any state securities commission, has approved or
disapproved these securities. Any representation to the contrary is a
criminal offense.
These securities are not deposits or accounts and are not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
The date of this Prospectus Supplement is November 10, 1999.
This prospectus supplement may be used only in connection with offers and
sales by Security Financial of interests or shares of common stock under the
401(k) Plan to employees of Security Federal. No one may use this prospectus
supplement to reoffer or resell interests or shares of common stock acquired
through the 401(k) Plan.
You should rely only on the information contained in this prospectus
supplement and the attached prospectus. Security Financial, Security Federal
and the 401(k) Plan have not authorized anyone to provide you with information
that is different.
This prospectus supplement does not constitute an offer to sell or
solicitation of an offer to buy any securities in any jurisdiction to any person
to whom it is unlawful to make an offer or solicitation in that jurisdiction.
Neither the delivery of this prospectus supplement and the prospectus nor any
sale of common stock shall under any circumstances imply that there has been no
change in the affairs of Security Federal or the 401(k) Plan since the date of
this prospectus supplement, or that the information contained in this prospectus
supplement or incorporated by reference is correct as of any time after the date
of this prospectus supplement.
TABLE OF CONTENTS
THE OFFERING................................................................................... 1
Securities Offered........................................................................ 1
Election to Purchase Security Financial Common Stock in the Conversion of
Security Federal..................................................................... 1
Value of Participation Interests.......................................................... 1
Method of Directing Transfer.............................................................. 1
Time for Directing Transfer............................................................... 2
Irrevocability of Transfer Direction...................................................... 2
Purchase Price of Security Financial Common Stock......................................... 2
Nature of a Participant's Interest in Security Financial Common Stock..................... 2
Voting and Tender Rights of Security Financial Common Stock............................... 2
DESCRIPTION OF THE 401(k) Plan................................................................. 3
Introduction.............................................................................. 3
Eligibility and Participation............................................................. 3
Contributions Under the 401(k) Plan....................................................... 3
Limitations on Contributions.............................................................. 3
Investment of Contributions............................................................... 4
Benefits Under the 401(k) Plan............................................................ 5
Withdrawals and Distributions From the 401(k) Plan........................................ 5
Administration of the 401(k) Plan......................................................... 6
Reports to 401(k) Plan Participants....................................................... 6
Plan Administrator........................................................................ 6
Amendment and Termination................................................................. 7
Merger, Consolidation or Transfer......................................................... 7
Federal Income Tax Consequences........................................................... 7
Restrictions on Resale.................................................................... 9
SEC Reporting and Short-Swing Profit Liability............................................ 9
LEGAL OPINIONS................................................................................. 10
INVESTMENT ELECTION FORM
THE OFFERING
Securities Offered
The securities offered in connection with this prospectus supplement are
participation interests in the 401(k) Plan. Assuming a purchase price of $10.00
per share, the trustee may acquire up to 142,945 shares of Security Financial
common stock for the Security Financial Stock Fund. The interests offered under
this prospectus supplement are conditioned on the completion of the conversion
of Security Federal. Your investment in the Security Financial Stock Fund in
connection with the conversion of Security Federal is also governed by the
purchase priorities contained in the plan of conversion of Security Federal.
This prospectus supplement contains information regarding the 401(k) Plan.
The attached prospectus contains information regarding the conversion of
Security Federal and the financial condition, results of operations and business
of Security Federal. The address of the principal executive office of Security
Federal is 9321 Wicker Avenue St. John, Indiana 46373. The telephone number of
Security Federal is (219) 365-4344.
Election to Purchase Security Financial Common Stock in the Conversion of
Security Federal
In connection with the conversion of Security Federal, the 401(k) Plan will
permit you to direct the trustee to transfer all or part of the funds which
represent your current beneficial interest in the assets of the 401(k) Plan to
the Security Financial Stock Fund. The trustee of the 401(k) Plan will subscribe
for Security Financial common stock offered for sale in connection with the
conversion of Security Federal in accordance with each participant's direction.
If the conversion offering is oversubscribed and some or all of your funds
cannot be used to purchase common stock in the conversion offering, the trustee
will reallocate the amount not invested in Security Financial common stock on a
proportionate basis to the other investment options you have selected. If you
fail to direct the investment of your account, your account balance will remain
in the other investment options of the 401(k) Plan.
All plan participants are eligible to direct a transfer of funds to the
Security Financial Stock Fund. However, such directions are subject to the
purchase priorities in the Security Federal plan of conversion. Your order will
be based on your status as an eligible account holder and supplemental eligible
account holder in the conversion of Security Federal. An eligible account holder
is a depositor whose savings account(s) totalled $50.00 or more on June 30,
1998. A supplemental eligible account holder is a depositor whose savings
account(s) totalled $50 or more on September 30, 1999. No eligible account
holders or supplemental eligible account holders may purchase in the
subscription offering more than $200,000 of Security Financial common stock. If
you fall into one of the above subscription offering categories, you have
subscription rights to purchase shares of common stock in the subscription
offering and you may use funds in the 401(k) Plan account to pay for Security
Financial common stock for which you subscribe. For purposes of investing in the
Security Financial Stock Fund in connection with the offering a minimum
investment of $250 is required.
Value of Participation Interests
As of August 31, 1999, the market value of the assets of the 401(k) Plan
equaled approximately $1,429,450. The plan administrator has informed each
participant of the value of his or her beneficial interest in the 401(k) Plan as
of June 30, 1999. The value of 401(k) Plan assets represents past contributions
to the 401(k) Plan on your behalf, plus or minus earnings or losses on the
contributions, less previous withdrawals.
Method of Directing Transfer
The last two pages of this prospectus supplement is a form for you to
direct a transfer to the Security Financial Stock Fund (the "Investment Election
Form"). If you wish to transfer all, or part in multiples of not less than 1%,
of your beneficial interest in the assets of the 401(k) Plan to the Security
Financial Stock Fund, you should complete the Investment Election Form. If you
do not wish to make such an election at this time, you do not need
1
to take any action. For purposes of investing in the Security Financial Stock
Fund in connection with the offering a minimum investment of $250 is required.
Time for Directing Transfer
The deadline for submitting a direction to transfer amounts to the Security
Financial Stock Fund in connection with the conversion of Security Federal is
December 6, 1999. You should return the Investment Election Form to Thomas
Baranko of Security Federal by 4:00 p.m. on December 6, 1999.
Irrevocability of Transfer Direction
Your direction to transfer amounts credited to such account in the 401(k)
Plan to the Security Financial Stock Fund cannot be changed.
Purchase Price of Security Financial Common Stock
The trustee will use the funds transferred to the Security Financial Stock
Fund to purchase shares of Security Financial common stock in the conversion of
Security Federal. The trustee will pay the same price for shares of Security
Financial common stock as all other persons who purchase shares of Security
Financial common stock in the conversion of Security Federal. If the conversion
offering is oversubscribed and some or all of your funds cannot be used to
purchase common stock in the conversion offering, the trustee will reallocate
the amount not invested in Security Financial common stock on a proportionate
basis to the other investment options you have selected. If you fail to direct
the investment of your account, your account balance will remain in the other
investment options of the 401(k) Plan.
Nature of a Participant's Interest in Security Financial Common Stock
The trustee will hold Security Financial common stock in the name of the
401(k) Plan. The trustee will allocate shares of common stock acquired at your
direction to your account under the 401(k) Plan. Therefore, earnings with
respect to your account should not be affected by the investment designations of
other participants in the 401(k) Plan.
Voting and Tender Rights of Security Financial Common Stock
The Trustee generally will exercise voting and tender rights attributable
to all Security Financial common stock held by the Security Financial Stock Fund
as directed by participants with interests in the Security Financial Stock Fund.
With respect to each matter as to which holders of Security Financial common
stock have a right to vote, you will be given voting instruction rights
reflecting your proportionate interest in the Security Financial Stock Fund. The
number of shares of Security Financial common stock held in the Security
Financial Stock Fund that are voted for and against on each matter will be
proportionate to the number of voting instruction rights exercised in such
manner. If there is a tender offer for Security Financial common stock, the
401(k) Plan provides that each participant will be allotted a number of tender
instruction rights reflecting such participant's proportionate interest in the
Security Financial Stock Fund. The percentage of shares of Security Financial
common stock held in the Security Financial Stock Fund that will be tendered
will be the same as the percentage of the total number of tender instruction
rights that are exercised in favor of tendering. The remaining shares of
Security Financial common stock held in the Security Financial Stock Fund will
not be tendered. The 401(k) Plan makes provisions for participants to exercise
their voting instruction rights and tender instruction rights on a confidential
basis.
2
DESCRIPTION OF THE 401(K) PLAN
I. Introduction
On December 18, 1997, Security Federal implemented the Security Federal
Bank, a Federal Savings Bank 401(k) Plan. Security Federal intends for the
401(k) Plan to comply, in form and in operation, with all applicable provisions
of the Internal Revenue Code and the Employee Retirement Income Security Act or
"ERISA." Security Federal may change the 401(k) Plan from time to time in the
future to ensure continued compliance with these laws. Security Federal may also
amend the 401(k) Plan from time to time in the future to add, modify, or
eliminate certain features of the plan, as it sees fit. As a plan governed by
the Employee Retirement Income Security Act of 1974, as amended, federal law
provides you with various rights and protections as a plan participant. Although
the 401(k) Plan is governed by many of the provisions of the Employee Retirement
Income Security Act of 1974, as amended, your benefits under the plan are not
guaranteed by the Pension Benefit Guaranty Corporation.
Reference to Full Text of Plan. The following portions of this prospectus
supplement provide an overview of the material provisions of the 401(k) Plan.
Security Federal qualifies this overview in its entirety by reference to the
full text of the 401(k) Plan. You may obtain copies of the full 401(k) Plan
document by sending a request to Joann Halterman at Security Federal. You should
carefully read the full text of the 401(k) Plan document to understand your
rights and obligations under the plan.
II. Eligibility and Participation
Any employee of Security Federal, other than hourly-paid employees, may
participate in the 401(k) Plan as of the first day of the month following his
commencement of employment with Security Federal.
As of September 30, 1999, 57 of the 87 eligible employees of Security
Federal elected to participate in the 401(k) Plan.
III. Contributions Under the 401(k) Plan
401(k) Plan Participant Contributions. The 401(k) Plan permits each
participant to annually defer receipt of up to 15% of compensation that Security
Federal would otherwise currently pay. For purposes of calculating deferrals,
the 401(k) Plan considers compensation to mean the amount which is actually paid
to a participant during the plan year, excluding bonuses, overtime, deferral
compensation and severance packages. However, by law, the 401(k) Plan may not
consider more than $160,000 of compensation for purposes of determining
deferrals for 1999. Participants in the 401(k) Plan may modify the amount
contributed to the plan on a bi-weekly basis.
Security Federal Contributions. Security Federal does not currently make
matching contributions or other employer contributions to the 401(k) Plan.
IV. Limitations on Contributions
Limitation on Employee Salary Deferral. Although the 401(k) Plan permits
you to defer up to 15% of your compensation, by law your total deferrals under
the 401(k) Plan, together with similar plans, may not exceed $10,000 for 1999.
The Internal Revenue Service will periodically increase this annual limitation.
Contributions in excess of this limitation, or excess deferrals, will be
included in an affected participant's gross income for federal income tax
purposes in the year they are made. In addition, a participant will have to pay
federal income taxes on any excess deferrals when distributed by the 401(k) Plan
to the participant, unless the excess deferral and any related income allocable
is distributed to the participant not later than the first April 15th following
the close of the taxable year in which the excess deferral is made. Any income
on the excess deferral that is distributed not later than such date shall be
treated, for federal income tax purposes, as earned and received by the
participant in the taxable year in which the distribution is made.
3
Limitations on Annual Additions and Benefits. Under the requirements of the
Internal Revenue Code, the 401(k) Plan provides that the total amount of
contributions and forfeitures (annual additions) allocated to a participant
during any year may not exceed the lesser of 25% of the participant's
compensation for that year, or $30,000. The 401(k) Plan will also limit annual
additions to the extent necessary to prevent the limitations contained in the
Internal Revenue Code for all of the qualified defined benefit plans and defined
contribution plans maintained by Security Federal from being exceeded.
Limitation on Plan Contributions for Highly Compensated Employees. Special
provisions of the Internal Revenue Code limit the amount of salary deferrals and
matching contributions that may be made to the 401(k) Plan in any year on behalf
of highly compensated employees in relation to the amount of deferrals and
matching contributions made by or on behalf of all other employees eligible to
participate in the 401(k) Plan. If these limitations are exceeded, the level of
deferrals by highly compensated employees must be adjusted.
In general, a highly compensated employee includes any employee who, (1)
was a five percent owner of the sponsoring employer at any time during the year
or preceding year, or (2) had compensation for the preceding year in excess of
$80,000 and, if the sponsoring employer so elects, was in the top 20% of
employees by compensation for such year. The dollar amounts in the foregoing
sentence are for 1999, but may be adjusted annually to reflect increases in the
cost of living.
Top-Heavy Plan Requirements. If for any calendar year the 401(k) Plan is a
Top-Heavy Plan, then Security Federal may be required to make certain minimum
contributions to the 401(k) Plan on behalf of non-key employees. In addition,
certain additional restrictions would apply with respect to the combination of
contributions to the 401(k) Plan and projected annual benefits under any defined
benefit plan maintained by Security Federal.
In general, the 401(k) Plan will be treated as a "Top-Heavy Plan" for any
calendar year if, as of the last day of the preceding calendar year, the
aggregate balance of the accounts of participants who are Key Employees exceeds
60% of the aggregate balance of the accounts of all participants. Key Employees
generally include any employee who, at any time during the calendar year or any
of the four preceding years, is:
(1) an officer of the Bank having annual compensation in excess of $60,000
who is in an administrative or policy-making capacity,
(2) one of the ten employees having annual compensation in excess of
$30,000 and owning, directly or indirectly, the largest interests in Security
Federal,
(3) a person who owns directly or indirectly more than 5% of the stock of
Security Financial, or stock possessing more than 5% of the total combined
voting power of all stock of Security Financial, or
(4) a person who owns directly or indirectly combined voting power of all
stock and more than 1% of the total stock of Security Financial and has annual
compensation in excess of $150,000.
The foregoing dollar amounts are for 1999.
V. Investment of Contributions
All amounts credited to participants' accounts under the 401(k) Plan are
held in trust. Security Federal acts as a directed trustee for all 401(k) Plan
investments. Either Security Federal or an independent trustee appointed by
Security Federal will serve as the trustee for the Security Financial Stock Fund
and purchase shares of Security Financial Common Stock in the conversion and
open market on behalf of plan participants.
4
Prior to the conversion of Security Federal, the 401(k) Plan offered the
following investment choices with annual rates of return as set forth below:
1998 1997 1996
---- ---- ----
Northern Institutional Diversified Assets Fund 5.39% 5.45% 5.79%
Federated Max-Cap Fund 28.27 32.69 22.75
Legg Mason Value Trust Primary Shares Fund 48.04 37.05 38.43
Scuddder Growth & Income Fund 6.07 30.31 22.18
Scudder International Fund 18.62 7.98 14.55
T. Rowe Price Equity Income Fund* 9.23 28.82 20.40
T. Rowe Price Small Cap Stock Fund (3.46) 28.81 21.05
Vanguard US Growth Fund 39.98 25.93 26.05
William Blair Growth Fund* 27.16 20.08 17.99
Federated High Yield Trust Fund 1.06 13.25 13.49
Northern Institutional Bond Portfolio Fund 9.29 9.96 3.46
Wright Current Income Fund 6.59 8.42 4.35
Federated Capital Preservation Fund - GIC 5.64 5.86 5.70
* New contributions or trustees may not be made to these funds.
For more information on these funds, please contact your plan
administrator.
The 401(k) Plan now provides the Security Financial Stock Fund as an
additional choice to these investment alternatives. The Security Financial Stock
Fund invests primarily in the common stock of Security Financial. Participants
in the 401(k) Plan may direct the employer stock fund trustee to invest all or a
portion of their 401(k) Plan account balance in the Security Financial Stock
Fund.
The Security Financial Stock Fund consists of investments in the common
stock of Security Financial made on the effective date of the conversion of
Security Federal. After the conversion of Security Federal, the trustee of the
401(k) Plan will, to the extent practicable, use all amounts held by it in the
Security Financial Stock Fund, including cash dividends paid on the common stock
held in the fund, to purchase shares of common stock of Security Financial.
As of the date of this prospectus supplement, none of the shares of common
stock have been issued or are outstanding and there is no established market for
the Security Financial common stock. Accordingly, there is no record of the
historical performance of the Security Financial Stock Fund. Performance of the
Security Financial Stock Fund depends on a number of factors, including the
financial condition and profitability of Security Financial and Security Federal
and market conditions for Security Financial common stock generally.
Investments in the Security Financial Stock Fund may involve certain
special risks in investments in the common stock of Security Financial. For a
discussion of these risk factors, see "Risk Factors" beginning on page 9 of the
prospectus.
VI. Benefits Under the 401(k) Plan
Vesting. You are always 100% vested in your elective deferrals under the
401(k) Plan.
VII. Withdrawals and Distributions From the 401(k) Plan
Withdrawals Before Termination of Employment. You may receive in-service
distributions from the 401(k) Plan under limited circumstances in the form of
hardship distributions, withdrawal of rollover contributions and loans. In order
to qualify for a hardship withdrawal, you must have an immediate and substantial
need to meet
5
certain expenses and have no other reasonably available resources to meet the
financial need. If you qualify for a hardship distribution, the trustee will
make the distribution proportionately from the investment funds in which you
have invested your account balances. In addition, you may apply for a loan under
the 401(k) Plan. A minimum amount of $1,000 can be borrowed from your 401(k)
Plan account. You may not receive more than one loan in any calendar year.
Distribution Upon Retirement or Disability. Upon retirement or disability,
you will receive a lump sum payment from the 401(k) Plan equal to the vested
value of your accounts.
Distribution Upon Death. If you die before your benefits are paid from the
401(k) Plan, your benefits will be paid to your surviving spouse or beneficiary
under one or more of the forms available under the 401(k) Plan.
Distribution Upon Termination for Any Other Reason. If you terminate
employment for any reason other than retirement, disability or death and your
account balance exceeds $3,500, the trustee will make your distribution on your
normal retirement date, unless you request otherwise. If your account balances
does not exceed $3,500, the trustee will generally distribute your benefits to
you as soon as administratively practicable following termination of employment.
Nonalienation of Benefits. Except with respect to federal income tax
withholding and as provided with respect to a qualified domestic relations
order, benefits payable under the 401(k) Plan shall not be subject in any manner
to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance,
charge, garnishment, execution, or levy of any kind, either voluntary or
involuntary, and any attempt to anticipate, alienate, sell, transfer, assign,
pledge, encumber, charge or otherwise dispose of any rights to benefits payable
under the 401(k) Plan shall be void.
Applicable federal tax law requires the 401(k) Plan to impose substantial
restrictions on your right to withdraw amounts held under the plan before your
termination of employment with Security Federal. Federal law may also impose an
excise tax on withdrawals made from the 401(k) Plan before you attain 59 1/2
years of age regardless of whether the withdrawal occurs during your employment
with Security Federal or after termination of employment.
Administration of the 401(k) Plan
The trustee with respect to the 401(k) Plan is the named fiduciary of the
401(k) Plan for purposes of ERISA.
Trustees. The trust department at Security Federal serves as agent to
Security Federal in its capacity as trustee for all of the assets of the 401(k)
Plan. Either Security Federal or an independent trustee appointed by Security
Federal will serve as the trustee of the Security Financial Stock Fund.
The trustee receives, holds and invests the contributions to the 401(k)
Plan in trust and distributes them to participants and beneficiaries in
accordance with the terms of the 401(k) Plan and the directions of the plan
administrator. The trustee is responsible for investment of the assets of the
trust.
Reports to 401(k) Plan Participants
The plan administrator will furnish you a statement at least quarterly
showing the balance in your account as of the end of that period, the amount of
contributions allocated to your account for that period, and any adjustments to
your account to reflect earnings or losses.
Plan Administrator
The current plan administrator of the 401(k) Plan is Security Federal. The
plan administrator is responsible for the administration of the 401(k) Plan,
interpretation of the provisions of the plan, prescribing procedures for
6
filing applications for benefits, preparation and distribution of information
explaining the plan, maintenance of plan records, books of account and all other
data necessary for the proper administration of the plan, and preparation and
filing of all returns and reports relating to the Plan which are required to be
filed with the U.S. Department of Labor and the Internal Revenue Service, and
for all disclosures required to be made to participants, beneficiaries and
others under Employee Retirement Income Security Act of 1974, as amended.
Amendment and Termination
Security Federal intends to continue the 401(k) Plan indefinitely.
Nevertheless, Security Federal may terminate the 401(k) Plan at any time. If
Security Federal terminates the 401(k) Plan in whole or in part, then regardless
of other provisions in the plan, all affected participants will become fully
vested in their accounts. Security Federal reserves the right to make, from time
to time, changes which do not cause any part of the trust to be used for, or
diverted to, any purpose other than the exclusive benefit of participants or
their beneficiaries; provided, however, that Security Federal may amend the plan
as it determines necessary or desirable, with or without retroactive effect, to
comply with the Employee Retirement Income Security Act of 1974, as amended, or
the Internal Revenue Code.
Merger, Consolidation or Transfer
If the 401(k) Plan merges or consolidates with another plan or transfers
the trust assets to another plan, and if either the 401(k) Plan or the other
plan is then terminated, the 401(k) Plan requires that you would receive a
benefit immediately after the merger, consolidation or transfer. The benefit
would be equal to or greater than the benefit you would have been entitled to
receive immediately before the merger, consolidation or transfer if the 401(k)
Plan had then terminated.
Federal Income Tax Consequences
The following is only a brief summary of the material federal income tax
aspects of the 401(k) Plan. You should not rely on this survey as a complete or
definitive description of the material federal income tax consequences relating
to the 401(k) Plan. Statutory provisions change, as do their interpretations,
and their application may vary in individual circumstances. Finally, the
consequences under applicable state and local income tax laws may not be the
same as under the federal income tax laws. You are urged to consult your tax
advisor with respect to any distribution from the 401(k) Plan and transactions
involving the plan.
As a "qualified retirement plan," the Code affords the 401(k) Plan special
tax treatment, including:
(1) The sponsoring employer is allowed an immediate tax deduction for the
amount contributed to the plan each year;
(2) participants pay no current income tax on amounts contributed by the
employer on their behalf; and
(3) earnings of the plan are tax-deferred thereby permitting the tax-free
accumulation of income and gains on investments.
Security Federal will administer the 401(k) Plan to comply in operation
with the requirements of the Internal Revenue Code as of the applicable
effective date of any change in the law. If Security Federal receives an
adverse determination letter regarding its tax exempt status from the Internal
Revenue Service, all participants would generally recognize income equal to
their vested interest in the 401(k) Plan, the participants would not be
permitted to transfer amounts distributed from the 401(k) Plan to an Individual
Retirement Account or to another qualified retirement plan, and Security Federal
may be denied certain deductions taken with respect to the 401(k) Plan.
7
Lump Sum Distribution. A distribution from the 401(k) Plan to a
participant or the beneficiary of a participant will qualify as a lump sum
distribution if it is made within one taxable year, on account of the
participant's death, disability or separation from service, or after the
participant attains age 59 1/2; and consists of the balance to the credit of the
participant under this plan and all other profit sharing plans, if any,
maintained by Security Federal. The portion of any lump sum distribution
required to be included in your taxable income for federal income tax purposes
consists of the entire amount of the lump sum distribution less the amount of
after-tax contributions, if any, you have made to any other profit sharing plans
maintained by Security Federal which is included in the distribution.
Averaging Rules. The portion of any lump sum distribution, required to be
included in your federal taxable income for federal income tax purposes,
attributable to participation after 1973 in the 401(k) Plan or in any other
profit-sharing plan maintained by Security Federal, known as the "ordinary
income portion," will be taxable generally as ordinary income for federal income
tax purposes. However, if you have completed at least five (5) years of
participation in the 401(k) Plan before the taxable year in which the
distribution is made, or receive a lump sum distribution on account of your
death, regardless of the period of your participation in this plan or any other
profit-sharing plan maintained by Security Federal, you may elect to have the
ordinary income portion of such lump sum distribution taxed according to a
special five-year averaging rule. The election of the special five-year
averaging rules may apply only to one lump sum distribution you or your
beneficiary receive, provided such amount is received on or after the date your
turn 59-1/2 and the recipient elects to have any other lump sum distribution
from a qualified plan received in the same taxable year taxed under the special
five-year averaging rule. Under a special grandfather rule, individuals who
turned 50 by 1986 may elect to have their lump sum distribution taxed under
either the five-year averaging rule or under the prior law ten-year averaging
rule. These individuals also may elect to have that portion of the lump sum
distribution attributable to the participant's pre-1974 participation in the
plan taxed at a flat 20% rate as gain from the sale of a capital asset.
Security Financial Common Stock Included in Lump Sum Distribution. If a
lump sum distribution includes Security Financial common stock, the distribution
generally will be taxed in the manner described above, except that the total
taxable amount will be reduced by the amount of any net unrealized appreciation
with respect to Security Financial common stock that is the excess of the value
of Security Financial common stock at the time of the distribution over its cost
or other basis of the securities to the trust. The tax basis of Security
Financial common stock for purposes of computing gain or loss on its subsequent
sale equals the value of Security Financial common stock at the time of
distribution less the amount of net unrealized appreciation. Any gain on a
subsequent sale or other taxable disposition of Security Financial common stock,
to the extent of the amount of net unrealized appreciation at the time of
distribution, will constitute long-term capital gain regardless of the holding
period of Security Financial common stock. Any gain on a subsequent sale or
other taxable disposition of Security Financial common stock in excess of the
amount of net unrealized appreciation at the time of distribution will be
considered long-term capital gain regardless of the holding period of Security
Financial common stock. Any gain on a subsequent sale or other taxable
disposition of Security Financial common stock in excess of the amount of net
unrealized appreciation at the time of distribution will be considered either
short-term, mid-term or long-term capital gain depending upon the length of the
holding period of Security Financial common stock. The recipient of a
distribution may elect to include the amount of any net unrealized appreciation
in the total taxable amount of the distribution to the extent allowed by the
regulations to be issued by the IRS.
Distributions: Rollovers and Direct Transfers to Another Qualified Plan or
to an IRA. You may roll over virtually all distributions from the 401(k) Plan
to another qualified plan or to an individual retirement account generally.
We have provided you with a brief description of the material federal
income tax aspects of the 401(k) Plan which are of general application under the
Code. It is not intended to be a complete or definitive description of the
federal income tax consequences of participating in or receiving distributions
from the 401(k) Plan. Accordingly, you are urged to consult a tax advisor
concerning the federal, state and local tax consequences of participating in and
receiving distributions from the 401(k) Plan.
8
Restrictions on Resale
Any person receiving a distribution of shares of common stock under the
401(k) Plan who is an "affiliate" of Security Financial under Rules 144 and 405
under the Securities Act of 1933, as amended, may reoffer or resell such shares
only under a registration statement filed under the Securities Act of 1933, as
amended, assuming the availability of a registration statement, under Rule 144
or some other exemption of the registration requirements of the Securities Act
of 1933, as amended. Directors, officers and substantial shareholders of
Security Financial are generally considered "affiliates." Any person who may be
an "affiliate" of Security Federal may wish to consult with counsel before
transferring any common stock they own. In addition, participants are advised
to consult with counsel as to the applicability of Section 16 of the Securities
Exchange Act of 1934, as amended, which may restrict the sale of Security
Financial common stock acquired under the 401(k) Plan, or other sales of
Security Financial common stock.
Persons who are not deemed to be "affiliates" of Security Federal at the
---
time of resale will be free to resell any shares of Security Financial common
stock distributed to them under the 401(k) Plan, either publicly or privately,
without regard to the registration and prospectus delivery requirements of the
Securities Act or compliance with the restrictions and conditions contained in
the exemptive rules under federal law. An "affiliate" of Security Federal is
someone who directly or indirectly, through one or more intermediaries,
controls, is controlled by, or is under common control, with Security Federal.
Normally, a director, principal officer or major shareholder of a corporation
may be deemed to be an "affiliate" of that corporation. A person who may be
deemed an "affiliate" of Security Federal at the time of a proposed resale will
be permitted to make public resales of the common stock only under a "reoffer"
prospectus or in accordance with the restrictions and conditions contained in
Rule 144 under the Securities Act of 1933, as amended, or some other exemption
from registration, and will not be permitted to use this prospectus in
connection with any such resale. In general, the amount of the common stock
which any such affiliate may publicly resell under Rule 144 in any three-month
period may not exceed the greater of one percent of Security Financial common
stock then outstanding or the average weekly trading volume reported on the
National Association of Securities Dealers Automated Quotation System during the
four calendar weeks before the sale. Such sales may be made only through
brokers without solicitation and only at a time when Security Financial is
current in filing the reports required of it under the Securities Exchange Act
of 1934, as amended.
SEC Reporting and Short-Swing Profit Liability
Section 16 of the Securities Exchange Act of 1934, as amended, imposes
reporting and liability requirements on officers, directors and persons
beneficially owning more than ten percent of public companies such as Security
Financial. Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the filing of reports of beneficial ownership. Within ten days of
becoming a person required to file reports under Section 16(a), a Form 3
reporting initial beneficial ownership must be filed with the Securities and
Exchange Commission. Certain changes in beneficial ownership, such as purchases,
sales, gifts and participation in savings and retirement plans must be reported
periodically, either on a Form 4 within ten days after the end of the month in
which a change occurs, or annually on a Form 5 within 45 days after the close of
Security Federal' fiscal year. Participation in the Security Financial Stock
Fund of the 401(k) Plan by officers, directors and persons beneficially owning
more than ten percent of common stock of Security Financial must be reported to
the SEC annually on a Form 5 by such individuals.
In addition to the reporting requirements described above, Section 16(b) of
the Securities Exchange Act of 1934 provides for the recovery by Security
Financial of profits realized by any officer, director or any person
beneficially owning more than ten percent of the common stock resulting from the
purchase and sale or sale and purchase of the common stock within any six-month
period.
The SEC has adopted rules that exempt many transactions involving the
401(k) Plan from the "short-swing" profit recovery provisions of Section 16(b).
The exemptions generally involve restrictions upon the timing of elections to
buy or sell employer securities for the accounts of any officer, director or any
person beneficially owning more than ten percent of the common stock.
9
Except for distributions of the common stock due to death, disability,
retirement, termination of employment or under a qualified domestic relations
order, persons who are governed by Section 16(b) may, under limited
circumstances involving the purchase of common stock within six months of the
distribution, be required to hold shares of the common stock distributed from
the 401(k) Plan for six months following the distribution date.
LEGAL OPINIONS
The validity of the issuance of the common stock of Security Financial will
be passed upon by Muldoon, Murphy & Faucette LLP, Washington, D.C. Muldoon,
Murphy & Faucette LLP acted as special counsel for Security Federal in
connection with the conversion of Security Federal.
10
INVESTMENT ELECTION FORM
Plan Name: Security Federal Bank, A Federal Savings Bank 401(k) Plan Plan # (3 digits) __________
---------------------------------------------------------
______________________________________________________________________________________________________
Participant Information (Employee Completes)
Name:
Social Security # __________________ Employee Number
Date of Birth ___/___/___ Date of Hire ___/___/___
Purchaser Information (Check One)
a) [_] Eligible Account Holder - Check here if you were a depositor with
$50 or more on deposit with Security Federal Bank as of June 30, 1998. Enter
information below for all deposit accounts that you had at Security Federal Bank
on June 30, 1998.
b) [_] Supplemental Eligible Account Holder - Check here if you were a
depositor with $50 or more on deposit with Security Federal Bank as of September
30, 1999 but are not an Eligible Account Holder. Enter information below for
all deposit accounts that you had at Security Federal Bank on September 30,
1999.
c) [_] Other Member - Check here if you were a depositor of Security
Federal Bank as of October 31, 1999, or borrower as of August 14, 1990 whose
loan continues to be outstanding as of October 31, 1999 but was not an Eligible
Account Holder or a Supplemental Eligible Account Holder. Enter information
below for all accounts that you had at Security Federal Bank on October 31,
1999.
Account Title (Names on Accounts) Account Number
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
Please note: Failure to list all of your accounts may results in the loss of
part or all of your subscription rights.
A. Investment Directions (Applicable to Accumulated Account Balances only)
I hereby revoke any previous investment direction and now direct that the market
value of the units that I have invested in the following funds, to the extent
permissible, be transferred out of the specified fund and invested (in whole
percentages) in the Security Financial Stock Fund as follows:
Northern Institutional Div. Assets Scudder International
---------------------------------- ____% --------------------- ____%
Federated Max-Cap T. Rowe Price Equity Income
----------------- ____% --------------------------- ____%
Legg Mason Value T. Rowe Price Small Cap.
---------------- ____% ------------------------ ____%
Scudder Growth Vanguard US Growth
-------------- ____% ------------------ ____%
William Blair Growth Federated High Yield
-------------------- ____% -------------------- ____%
Northern Institutional Bond Wright Current Income
--------------------------- ____% --------------------- ____%
Federated Capital Preservation(GIC) ____%
-----------------------------------
Note: The total amount transferred may not exceed the total value of your
accounts.
11
B. Investment Directions (Applicable to Future Contributions Only)
I hereby revoke any previous investment instructions and now direct that any
future contributions made by me or on my behalf by Security Federal, including
those contributions received by the 401(k) Plan during the same reporting period
as this form, be invested in the following whole percentages.
Northern Institutional Div. Assets Scudder International
- ---------------------------------- ____% --------------------- ____%
Federated Max-Cap T. Rowe Price Small Cap.
- ----------------- ____% ------------------------ ____%
Legg Mason Value Vanguard US Growth
- ---------------- ____% ------------------ ____%
Scudder Growth Federated High Yield
- -------------- ____% -------------------- ____%
Northern Institutional Bond Wright Current Income
- --------------------------- ____% --------------------- ____%
Federated Capital Preservation(GIC) Security Financial Bancorp, Inc
- ----------------------------------- ____% -------------------------------
Stock Fund
---------- ____%
*Note: Total of percentage selected must equal 100% and you may not select fractional percentages (i.e., 33 1/3%). 100%
===
________________________________________________________________________________
SIGNATURES
_______________________________ _______/_______/________
Participant Date
Security Federal is hereby authorized to make the above listed changes.
___________________________________ _______/_______/________
Signature of Security Federal Bank Date
Authorized Representative
12
Filed pursuant to Rule 424(B)(3)
Registration No. 333-87397
PROSPECTUS [LOGO]
SECURITY FINANCIAL BANCORP, INC.
(Proposed Holding Company for Security Federal Bank & Trust)
2,127,500 Shares of Common Stock
Security Federal Bank, a Federal Savings Bank is converting from the mutual form
to the stock form of organization. As part of the conversion, Security
Financial Bancorp, Inc. is offering its shares of common stock to the public.
As part of the conversion, Security Federal Bank, a Federal Savings Bank will
change its name to Security Federal Bank & Trust and Security Financial will own
Security Federal.
Price Per Share: $10.00
Expected Trading Market: Nasdaq SmallCap Market
Proposed Trading Symbol: "SFBI"
Minimum Maximum
----------- -----------
Number of shares: 1,572,500 2,127,500
Gross offering proceeds: $15,725,000 $21,275,000
Estimated underwriting commissions
and other offering expenses: $ 654,000 $ 723,000
Estimated net proceeds: $15,071,000 $20,552,000
Estimated net proceeds per share: $ 9.58 $ 9.66
With the approval of the Office of Thrift Supervision, Security Financial may
increase the maximum number of shares by up to 15%, to 2,446,625 shares.
Charles Webb & Company, A Division of Keefe, Bruyette & Woods, Inc., will use
its best efforts to assist Security Financial in selling at least the minimum
number of shares but does not guarantee that this number will be sold. Webb is
not obligated to purchase any shares of common stock in the offering. Keefe,
Bruyette & Woods, Inc. intends to make a market in the common stock.
The offering to depositors and borrowers of Security Federal will end at 12:00
noon, Central time, on December 15, 1999. An offering to the general public may
also be held and may end as early as 12:00 noon, Central time, on December 15,
1999. If the conversion is not completed by January 29, 2000, and the Office of
Thrift Supervision gives Security Federal more time to complete the conversion,
Security Financial will allow all subscribers to increase, decrease or cancel
their orders. All extensions may not go beyond December 27, 2001. Security
Financial will hold all funds of subscribers in an interest-bearing savings
account at Security Federal until the conversion is completed or terminated.
Funds will be returned promptly with interest payable at Security Federal's
passbook rate, if the conversion is terminated.
- --------------------------------------------------------------------------------
These securities are not deposits or accounts and are not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
For a discussion of risks that you should consider, see "Risk Factors" beginning
on page 9.
Neither the Securities and Exchange Commission, the Office of Thrift
Supervision, nor any state securities commission has approved or disapproved of
these securities or determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
- --------------------------------------------------------------------------------
For assistance, please contact the stock information center at (219) 365-6251.
CHARLES WEBB & COMPANY
A Division of
KEEFE, BRUYETTE & WOODS, INC.
The date of this prospectus is November 10, 1999
TABLE OF CONTENTS
Page
----
Questions and Answers About the Stock Offering........................... (i)
Summary.................................................................. 1
Risk Factors............................................................. 9
Selected Financial Information........................................... 14
Recent Developments...................................................... 16
Use of Proceeds.......................................................... 20
Security Financial Dividend Policy....................................... 21
Market for the Common Stock.............................................. 22
Capitalization........................................................... 23
Historical and Pro Forma Regulatory Capital Compliance................... 24
Pro Forma Data........................................................... 25
Shares to be Purchased by Management with Subscription Rights............ 29
Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................. 30
Business of Security Financial........................................... 40
Business of Security Federal............................................. 40
Management of Security Financial......................................... 63
Management of Security Federal........................................... 64
Regulation and Supervision............................................... 74
Federal and State Taxation............................................... 80
The Conversion........................................................... 82
Restrictions on Acquisition of Security Financial........................ 97
Description of Capital Stock of Security Financial....................... 102
Registration Requirements................................................ 104
Legal and Tax Opinions................................................... 104
Experts.................................................................. 104
Where You Can Find More Information...................................... 104
Index to Consolidated Financial Statements............................... 105
QUESTIONS AND ANSWERS ABOUT THE STOCK OFFERING
The following are frequently asked questions. You should read this entire
prospectus, including "Risk Factors" beginning on page 9 and "The Conversion"
beginning on page 82, for more information.
Q. How Many Shares of Stock are Being Offered, and at What Price?
A. We are offering for sale up to 2,127,500 shares of common stock at a
subscription price of $10.00 per share. We must sell at least
1,572,500 shares. If there is strong demand for the common stock in
the offering, then the independent appraiser retained by us to
determine the pro forma market value of Security Financial may
conclude that the appraised market value of the common stock has
changed due to changing stock market or financial conditions. In that
case, without notice to you, we may be required to sell up to
2,446,625 shares.
Q. What Particular Factors Should I Consider When Deciding Whether to Purchase
the Stock?
A. There are many important factors for you to consider before making an
investment decision. Therefore, you should read this entire prospectus
before making your investment decision.
Q. How Do I Sell My Stock After I Purchase It?
A. We expect our stock to be quoted on the Nasdaq SmallCap Market under
the symbol "SFBI." Purchases and sales of our common stock will be
effected by brokers through the Nasdaq SmallCap Market. There can be
no assurance that someone will want to buy your shares or that you
will be able to sell them for more money than you originally paid. You
should consider the possibility that you may be unable to easily sell
our stock. There may also be a wide spread between the bid and asked
price for our stock.
Q. Will My Stock be Covered by Deposit Insurance or Guaranteed by any
Government Agency?
A. No. Unlike insured deposit accounts at Security Federal, our stock
will not be insured or guaranteed by the Federal Deposit Insurance
Corporation or any other government agency.
Q. When is the Deadline to Subscribe for Stock?
A. We must receive a properly signed order form with the required payment
on or before 12:00 noon, Central time on December 15, 1999.
Q. Can the Offering Be Extended?
A. Yes. If we do not receive sufficient orders, we can extend the
offering beyond December 15, 1999. We must complete any offering to
general members of the public within 45 days after the close of the
subscription offering, unless we receive regulatory approval to
further extend the offering. No single extension can exceed 90 days,
and the extensions may not go beyond December 27, 2001.
Q. How Do I Purchase Stock?
A. First, you should read this entire prospectus carefully. Then,
complete and return the enclosed stock order and certification form,
together with your payment. Subscription orders may be delivered in
person to our office during regular banking hours, or by mail in the
enclosed business reply envelope. Subscription orders received after
the
(i)
subscription offering expiration date may be held for participation in
any community offering. If the stock offering is not completed by
December 15, 1999 and is not extended, then all funds will be returned
promptly with interest, and all withdrawal authorizations will be
cancelled.
Q. Can I Change My Mind After I Place an Order to Subscribe for Stock?
A. No. After we receive your order form and payment, you may not cancel
or modify your order. However, if we extend the offering beyond
December 15, 1999, you will be able to change or cancel your order. If
you cancel your order, you will receive a prompt refund plus interest.
Q. How Can I Pay for the Stock?
A. You have two options: (1) send us a check or money order, or (2)
authorize a withdrawal from your deposit account at Security Federal
(without any penalty for early withdrawal). Please do not send cash in
the mail.
Q. Will I Receive Interest on my Subscription Payment?
A. Yes. Subscription payments will be placed in an interest-bearing
escrow account at Security Federal and will earn interest at our
savings account rate. Depositors who elect to pay by withdrawal will
continue to receive interest on their accounts until the funds are
withdrawn.
Q. Can I Subscribe for Shares Using Funds in my Individual Retirement Account
at Security Federal?
A. Yes. However, you cannot purchase stock with your existing IRA at
Security Federal. You must establish a self-directed IRA with an
outside trustee to subscribe for stock using your IRA funds. Please
call our Stock Information Center at (219) 365-6251 to get more
information. Please understand that the transfer of IRA funds takes
time, so please make arrangements as soon as possible.
Q. What Happens if There Are Not Enough Shares of Stock to Fill all Orders?
A. If there is an oversubscription, then you may not receive any or all
of the shares you want to purchase.
Q. Who Can Help Answer Any Other Questions I May Have About the Stock
Offering?
A. For answers to other questions, we encourage you to read this
prospectus. Questions may also be directed to our Stock Information
Center at (219) 365-6251 between the hours of 9:00 a.m. and 5:00 p.m.
Q. Are There any Restrictions on the Acquisition of Security Financial by
Means of a Tender Offer, Proxy Contest or otherwise?
A. Yes. Security Financial's Certificate of Incorporation and Bylaws
contain certain provisions that could make more difficult an
acquisition of Security Financial by means of a tender offer, proxy
context or otherwise. Certain provisions will also render the removal
of the incumbent Board of Directors or management of Security
Financial more difficult. These provisions may have the effect of
deterring a future takeover attempt that is not approved by the
Security Financial Board of Directors.
(ii)
SUMMARY
You should read the entire prospectus carefully before you decide to
invest. For assistance, please contact the stock information center at
(219) 365-6251.
The Companies
Security Financial Bancorp, Security Federal formed Security Financial to be
Inc. (page 40) its holding company. To date, Security Financial
9321 Wicker Avenue has only conducted organizational activities.
St. John, Indiana 46373 After the conversion, it will own all of Security
(219) 365-4344 Federal's outstanding capital stock and will
direct, plan and coordinate Security Federal's
business activities. After the conversion,
Security Financial might become an operating
company or acquire or organize other operating
subsidiaries, including other financial
institutions, although it currently has no
specific plans or agreements to do so.
Security Federal Bank, a Security Federal is a community bank dedicated to
Federal Savings Bank serving the financial service needs of consumers
(page 40) within its primary market area. Currently,
Security Federal operates out of its main office
in St. John, Indiana and its six branch offices in
Lake and Porter counties, and considers its
primary market area for making loans and
attracting deposits to include Lake and Porter
counties in Indiana, as well as Cook and Will
counties in Illinois. Immediately following the
consummation of Security Federal's conversion to
stock form, Security Federal's corporate title
will change to Security Federal Bank & Trust.
Security Federal's principal business is
attracting deposits from the general public and
using those funds to originate one-to four-family
residential mortgage loans, which accounted for
57.4% of Security Federal's total loan portfolio
at June 30, 1999. Security Federal also makes
multi-family and commercial real estate,
construction, consumer, including home equity
loans, and commercial business loans. In the
future, Security Federal intends to increase its
emphasis on consumer, including home equity
lending, construction, commercial real estate and
commercial business lending. Security Federal also
invests, to a limited extent, in U.S. government
and agency securities and U.S. government insured
or guaranteed mortgage-backed securities. At June
30, 1999, Security Federal had total assets of
$191.5 million, deposits of $165.9 million and
total equity of $18.5 million.
Security Federal has recently undergone some
changes in management and in its strategic plan.
Five new directors have been added to the Board
since the beginning of 1997, including John P.
Hyland who was hired as President and Chief
Executive Officer of Security Federal in October
1998 and became a director in 1999. Under the
direction of Mr. Hyland and the Board of
Directors, Security Federal changed its business
strategy from a growth strategy achieved
1
through expansion of Security Federal's mortgage
banking and loan servicing operations to a
strategy of originating higher yielding loans and
seeking means of attaining fee income, while
managing growth, maintaining asset quality and
reducing expenses. For a discussion of Security
Federal's past and present business strategies and
recent results of operations, see "Management's
Discussion and Analysis of Financial Condition and
Results of Operations." For a discussion of
Security Federal's business activities, see
"Business of Security Federal."
The Conversion
What is the Conversion The conversion is a change in Security Federal's
(page 82) legal form of organization. As a mutual savings
bank, Security Federal currently has no stock or
stockholders. Instead, Security Federal operates
for the benefit of its depositors who elect its
directors and vote on other important matters.
Through the conversion, Security Federal will
become a stock savings bank and will be owned and
controlled by the holder of all its stock,
Security Financial. Voting rights in Security
Financial will belong to its stockholders.
Security Federal is conducting the conversion
under the terms of its plan of conversion. The
Office of Thrift Supervision has approved the plan
of conversion, with the condition that Security
Federal's members approve the plan of conversion.
Security Federal has called a special meeting for
December 27, 1999 to vote on the plan of
conversion.
Reasons for the Conversion By converting to the stock form of organization,
(page 83) Security Federal will be structured in the form
used by commercial banks, most business entities
and a large number of savings institutions. The
conversion will be important to Security Federal's
future growth and performance because it will:
. enhance its ability to attract and retain
qualified management through stock-based
compensation plans;
. expand its ability to serve the public;
. provide a larger capital base from which to
operate;
. enhance its ability to expand through the
acquisition of other financial institutions or
their assets; and
. enhance its ability to diversify into other
financial services related activities.
2
Benefits of the Conversion Security Financial and Security Federal intend to
to Management (page 68) adopt the following benefit plans and employment
agreements:
. Employee Stock Ownership Plan. This plan
intends to purchase 8% of the shares issued in
the conversion. This would range from 125,800
shares, assuming 1,572,500 shares are issued in
the conversion, to 170,200 shares, assuming
2,127,500 shares are issued in the conversion.
Security Federal will allocate these shares to
employees over a period of years in proportion
to their compensation.
. Employment Agreements. Security Financial and
Security Federal intend to enter into
employment agreements with Mr. John P. Hyland
who will receive a base salary under the
agreements of $175,000. These agreements will
provide for severance benefits if the executive
is terminated following a change in control of
Security Financial or Security Federal.
. Supplemental Executive Retirement Plan. This
plan will provide eligible individuals with
benefits that otherwise would be provided under
the employee stock ownership plan but for
certain limitations imposed by the Internal
Revenue Code.
. Employee Severance Compensation Plan. This plan
will provide severance benefits to eligible
employees if there is a change in control of
Security Financial or Security Federal.
. Stock-Based Incentive Plan. Not less than six
months following completion of the conversion,
Security Financial intends to adopt this plan
pursuant to which it may award stock options to
key employees and directors. No determinations
have been made as to who may be awarded options
or the amount that may be awarded. The number
of options that would be available under this
plan will be equal to not more than 10% of the
number of shares sold in the conversion. This
would range from 157,250 shares, assuming
1,572,500 shares are issued in the conversion,
to 212,750 shares, assuming 2,127,500 shares
are issued in the conversion. This plan will
require shareholder approval.
In addition, under this plan, Security
Financial would be able to award shares of
restricted stock to key employees and directors
at no cost to the recipient. No determinations
have been made as to who may be awarded shares
of stock or the amounts that may be awarded.
The number of shares available for stock awards
will be equal to not more than 4% of the number
of shares issued in the conversion. This would
range from 62,900 shares, assuming 1,572,500
shares are issued
3
in the conversion, to 85,100 shares, assuming
2,127,500 shares are issued in the conversion.
The following table summarizes the total number
and dollar value of the shares of common stock,
assuming 2,127,500 shares are issued in the
conversion, which the employee stock ownership
plan expects to acquire and the total value of all
shares that are expected to be available for award
under the stock-based incentive plan. The table
assumes the value of the shares is $10.00 per
share. The table does not include a value for the
options because their value would be equal to the
fair market value of the common stock on the day
that the options are granted. As a result,
financial gains can be realized on an option only
if the market price of common stock increases
above the price at which the options are granted.
Percentage
of Shares
Number Estimated Issued
of Value in the
Shares of Shares Conversion
------ --------- ----------
Employee stock ownership plan .......... 170,200 $1,702,000 8.0%
Stock-based incentive plan:
Stock awards.......................... 85,100 851,000 4.0
Stock options......................... 212,750 -- 10.0
------- ---------- ----
Total............................... 468,050 $4,680,500 22.0%
======= ========== ====
For a discussion of risks associated with these
plans and agreements, see "Risk Factors--
Implementation of additional benefit plans will
increase future compensation expense and may lower
Security Federal's net income," and
"Risk Factors--Potential acquirers may be
discouraged from pursuing the acquisition of
Security Financial because of the existence of the
employment agreement and the severance plan," and
"Risk Factors--Issuance of shares for benefit
programs could reduce your ownership interest."
The Offering
Subscription Offering Security Federal has granted subscription rights
(page 86) in the following order of priority to:
Note: Subscription rights 1. Persons with $50 or more on deposit, including
are not transferable, and all withdrawable deposits at Security Federal,
persons with subscription including non-interest bearing demand
rights may not subscribe deposits, at Security Federal as of June 30,
for shares for the benefit 1998.
of any other person. If you
violate this prohibition,
you may lose your rights to 2. The Security Federal employee stock ownership
purchase shares and may plan, which provides retirement benefits to
face criminal prosecution Security Federal's employees.
and /or other sanctions.
4
3. Persons with $50 or more on deposit, including
all withdrawable deposits at Security Federal,
including non-interest bearing demand
deposits, at Security Federal as of September
30, 1999.
4. Security Federal's depositors, including
persons with withdrawable deposits at Security
Federal, including non-interest bearing demand
deposits, as of October 31, 1999 and borrowers
of Security Federal as of August 14, 1990
whose loans continue to be outstanding as of
October 31, 1999.
If the offering is oversubscribed, shares will be
allocated in order of the priorities described
above under a formula outlined in the plan of
conversion.
Security Financial may offer shares not sold in
the subscription offering to the general public in
a community offering. People and trusts of people
who are residents of Lake and Porter Counties,
Indiana will have first preference to purchase
shares in a community offering. If shares are
available, Security Financial expects to offer
them to the general public immediately after the
end of the subscription offering, but may begin a
community offering at any time during the
subscription offering.
To ensure that Security Federal properly
identifies your subscription rights, you must list
all of your savings accounts and loans as of the
eligibility dates on the stock order form. If you
fail to do so, your subscription may be reduced or
rejected if the offering is oversubscribed.
Deadline for Ordering The subscription offering will end at 12:00 noon,
Common Stock (page 88) Central time, on December 15, 1999.
Purchase Price The purchase price is $10.00 per share. The Boards
of Directors of Security Financial and Security
Federal consulted with Charles Webb & Company
("Webb") A Division of Keefe, Bruyette & Woods,
Inc. ("KBW") in determining the purchase price.
Number of Shares to be Security Financial is offering for sale between
sold (page 92) 1,572,500 and 2,127,500 shares of its common stock
in this offering. With regulatory approval,
Security Financial may increase the number of
shares to 2,446,625 without giving you further
notice or the opportunity to change or cancel your
order.
How the Offering Range was The offering range is based on an independent
Determined (page 92) appraisal of Security Federal by Keller & Company,
Inc., an appraisal firm experienced in appraisals
of savings institutions. Keller & Company has
estimated that as of October 20, 1999, Security
Federal's market value ranged between $15.7
million and $21.3 million, with a midpoint of
$18.5 million. This results in an offering of
between 1,572,500 and 2,127,500 shares of
5
stock at an offering price of $10.00 per share.
Keller & Company's appraisal was based in part on
Security Federal's financial condition and results
of operations and the effect on Security Federal
of the additional capital raised by the sale of
common stock in this offering. Keller & Company's
independent appraisal will be updated before the
conversion is completed.
In preparing its independent appraisal, Keller &
Company focused primarily on the price/core
earnings and price/book valuation methodologies,
both of which are discussed in the appraisal
report. See "Where You Can Find More Information"
for how to obtain a copy of the appraisal report.
The following table compares Security Federal's
pro forma price/core earnings and price/book
ratios at the minimum and maximum of the offering
range to the averages for all publicly traded
thrift institutions, all publicly traded Indiana
thrift institutions and a comparable group of ten
publicly traded thrift institutions identified in
the appraisal report. Thrift institutions in the
mutual holding company structure are excluded from
each comparison group.
Price/Core
Earnings Price/Book
Ratio Ratio
---------- ----------
Security Federal:
Minimum............................ * 49.58
Maximum............................ * 58.24
All Publicly Traded Thrifts........... 17.39 122.85
All Publicly Traded Indiana Thrifts... 15.58 103.75
Comparable Group...................... 24.92 90.27
___________________________
*Not meaningful
The independent appraisal does not indicate market
value. Do not assume or expect that Security
Federal's discounted valuation as shown in the
above table means that the common stock will trade
at or above the $10.00 purchase price after the
conversion. Security Financial cannot guarantee
that anyone who purchases shares in the conversion
will be able to sell their shares at or above the
$10.00 purchase price. See "Risk Factors--Possible
limited market for Security Financial's common
stock could negatively affect the market price."
Purchase Limitations Orders for common stock will be limited in the
(page 94) following ways:
. The minimum purchase is 25 shares.
. The maximum purchase in the subscription
offering by any person or group of persons
through a single deposit account is $200,000 of
common stock, which equals 20,000 shares.
6
. The maximum purchase by any person in the
community offering is $200,000 of common stock,
which equals 20,000 shares.
. The maximum purchase in the subscription
offering and community offering combined by any
person, related persons or persons acting
together is $400,000 of common stock, which
equals 40,000 shares.
How to Purchase Common Stock If you want to subscribe for shares in the
(page 91) subscription offering or place a purchase order
for shares in the community offering, you must
complete an original stock order form and send it
together with full payment to Security Federal in
the postage-paid envelope provided. You must sign
the certification that is part of the stock order
form. Security Federal must receive your stock
order form before the end of the subscription
offering or the end of the community offering, as
appropriate.
You may pay for shares in the subscription
offering or the community offering in any of the
following ways:
. By check or money order made payable to
Security Financial Bancorp, Inc.
. By withdrawal from an account at Security
Federal. To use funds in an Individual
Retirement Account at Security Federal, you
must transfer your account to an unaffiliated
institution or broker. Please contact the
stock information center at least one week
before the end of the subscription offering or
the community offering, as appropriate, for
assistance.
Security Federal will pay interest on your
subscription funds at the rate it pays on passbook
accounts from the date it receives your funds
until the conversion is completed or terminated.
All funds authorized for withdrawal from deposit
accounts with Security Federal will earn interest
at the applicable account rate until the
conversion is completed. There will be no early
withdrawal penalty for withdrawals from
certificates of deposit used to pay for stock.
Note: Once Security Financial receives your order,
you cannot cancel or change it without Security
Financial's consent. If Security Financial intends
to sell fewer than 1,572,500 shares or more than
2,446,625 shares, all those who subscribed in the
offering will be notified and given the
opportunity to change or cancel their orders. If
you do not respond to this notice, Security
Financial will return your funds promptly with
interest.
7
How Security Financial and Security Financial will pay 50% of the net
Security Federal Will offering proceeds to Security Federal
Use the Proceeds of this to buy all of the common stock of Security
Offering (page 20) Federal. Security Federal will use
these funds to originate loans and purchase
investments similar to the kinds it
currently holds.
Security Financial will also loan an amount equal
to 8% of the gross proceeds of the offering to the
employee stock ownership plan to fund its purchase
of common stock and will keep the remainder of the
net proceeds for general corporate purposes. These
purposes may include, for example, paying cash
dividends or buying back shares of common stock.
Security Financial and Security Federal may also
use the proceeds of the offering to expand and
diversify their businesses, although they have no
specific plans to do so at this time.
Purchases by Directors and Security Federal's directors and executive
Executive Officers (page 29) officers intend to subscribe for 131,600 shares,
regardless of the number of shares issued in the
conversion, which equals 6.2% of the 2,127,500
shares that would be issued at the maximum of the
offering range. If fewer shares are issued in the
conversion, then directors and executive officers
would own a greater percentage of Security
Financial. Directors and executive officers will
pay the $10.00 per share price as will everyone
else who purchases shares in the conversion.
Market for Common Stock Security Financial intends to list the common
(page 22) stock on The Nasdaq SmallCap Market. KBW intends
to be a market maker in the common stock. After
shares of the common stock begin trading, you may
contact a stock broker to buy or sell shares.
Security Financial cannot assure you that there
will be an active trading market for the common
stock.
Security Financial's Security Financial may adopt a policy of paying
Dividend Policy (page 21) regular cash dividends in the future, but has not
decided the amount that may be paid or when the
payments may begin, if at all.
8
RISK FACTORS
Before investing in Security Financial's common stock please carefully
consider the matters discussed below.
Security Federal has reported negative earnings for each of the last three
fiscal years
Security Federal has not been profitable in any of the last three fiscal
years. Security Federal reported net losses of $608,000, $834,000 and $1.2
million for each of the three fiscal years ended June 30, 1999, 1998 and 1997,
respectively. Management has sought to improve earnings by reducing non-interest
and interest expenses, which has had a positive impact. Although management is
optimistic that it can produce positive net income by pursuing its current
strategic plan, there can be no assurance that Security Financial will become
profitable, or remain profitable if profitability is attained. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Management's Strategy" for more information regarding historical earnings and
Security Financial's strategic plan.
Security Federal's return on equity has been negative and will likely continue
to be below average after conversion
Return on equity, which equals net income divided by average equity, is a
ratio used by many investors to compare the performance of a particular company
with other companies. In recent years, Security Federal's return on equity has
been negative because Security Federal has realized a net loss in each of the
last three fiscal years. Management has taken many steps to improve earnings.
There can be no assurance, however, that Security Financial's return on equity
will equal or exceed the average return on equity for publicly traded savings
associations and banks of comparable size. This is due largely because Security
Financial is unable to estimate what its earnings will be in the future.
Further, the proceeds raised through the conversion offering will have the
effect of increasing equity, which will have a negative effect on Security
Financial's ability to improve its return on equity through increased earnings.
In addition, compensation expense will increase as a result of the new benefit
plans. In addition, other expenses related to operating as a public company will
also increase non-interest expense, which will partially offset the effect that
the recent reductions in expenses that management has made would have on net
income.
Over time, Security Financial intends to use the net proceeds from this
offering to increase earnings per share and book value per share, without
assuming undue risk. The ultimate goal of Security Financial is to achieve a
return on equity competitive with other publicly traded financial institutions.
This goal could take a number of years to achieve, and Security Financial cannot
assure you that this goal can be attained. Consequently, you should not expect a
competitive return on equity in the near future.
Security Federal's non-interest expense has been, and continues to be, higher
than average for publicly traded savings associations and banks of comparable
size
Security Federal's operating expenses have been higher than average
compared to those of similarly sized savings associations in recent years. Much
of the expenses were incurred in connection with Security Federal's growth
strategy, which has been terminated. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Management's Strategy."
Although management has reduced non-interest expense from $13.6 million for the
fiscal year ended June 30, 1998 to $10.3 million for the fiscal year ended June
30, 1999, Security Federal's operating expenses continue to substantially exceed
those of other similarly sized savings associations and will continue to
adversely affect net income. Management is continuing to address means of
reducing non-interest expense.
9
Security Federal's new strategic plan was recently implemented and has not yet
had the time to be proven successful
Beginning late in 1998, Security Federal began to change its business
strategy. Specifically, it changed from a growth strategy achieved through
expansion of Security Federal's mortgage banking and loan servicing operations
to a more traditional savings and loan business. Security Federal now pursues a
strategy of originating loans, with an emphasis on higher-yielding loans, and
seeking means of attaining fee income. Security Federal attempts to pursue this
strategy while managing growth, maintaining asset quality and reducing expenses.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations." There can be no assurance that Security Federal's new strategic
plan will ultimately produce positive results.
Loss of key personnel may hurt Security Federal's operations
John P. Hyland, Security Federal's President and Chief Executive Officer,
has been instrumental in managing the business affairs and changing the business
strategy of Security Federal during the past year. The loss of Mr. Hyland could
have a material adverse impact on the operations of Security Federal. Security
Federal does not have an established management succession plan. Accordingly,
should Security Federal lose the services of Mr. Hyland, the Board of Directors
would have to search outside of Security Federal for a qualified, permanent
replacement. This search may be prolonged and Security Federal cannot assure you
that it will be able to locate and hire a qualified replacement. Neither
Security Federal nor Security Financial has any plans to obtain a "key man" life
insurance policy for Mr. Hyland. For a discussion of Security Federal's
management, see "Management of Security Federal."
Security Federal's net interest income may decrease due to competition for loans
and deposits in Security Federal's market area
Security Federal faces intense competition both in making loans and
attracting deposits. This competition has made it more difficult for Security
Federal to make new loans and has forced it, on occasion, to offer higher
deposit rates in its market area. Competition for loans and deposits may
contribute to a narrowing of its interest rate spread, which could hurt net
interest income. Security Federal's interest rate spread has grown in recent
years. This is due, however, largely to Security Federal's change in business
strategy and corresponding decision to reduce its mortgage banking operation and
sell a significant amount of loans. This enabled Security Federal to repay high
cost borrowings that had funded Security Federal's former asset growth strategy.
The change in strategy also resulted in Security Federal no longer aggressively
seeking jumbo deposits for which Security Federal paid a high rate of interest.
See "Management Discussion and Analysis of Financial Condition and Results of
Operations--Management Strategy." The competition for deposits, particularly
from mutual funds and other stock market investment vehicles, has contributed to
slower growth in Security Federal's core deposit base in recent years. Security
Federal expects that the competition for loans and deposits will continue to be
intense and may increase in the future. For more information about Security
Federal's market area and the competition it faces, see "Business of Security
Federal--Market Area" and "Business of Security Federal--Competition."
Management will have substantial discretion over investment of the offering
proceeds and may make investments with which you may disagree
The net offering proceeds to Security Federal are estimated to range from
$7.5 million to $10.3 million. The net offering proceeds to Security Financial
are estimated to range from $6.3 million to $8.6 million after it loans a
portion of the proceeds to Security Federal's employee stock ownership plan to
purchase shares of common stock. Security Financial and Security Federal intend
to use these funds for general business purposes, giving management substantial
discretion over their investment. You may disagree with investments that
management makes. See "Use of Proceeds" for further discussion.
10
Implementation of additional benefit plans will increase future compensation
expense and may lower Security Federal's net income
Security Federal will recognize additional material employee compensation
and benefit expenses stemming from the shares purchased or granted to employees
and executives under new benefit plans. Security Federal cannot predict the
actual amount of these new expenses because applicable accounting practices
require that they be based on the fair market value of the shares of common
stock at specific points in the future. Security Federal would recognize
expenses for its employee stock ownership plan when shares are committed to be
released to participants' accounts and would recognize expenses for the stock-
based incentive plan over the vesting period of awards made to recipients. These
expenses have been estimated in the pro forma financial information under "Pro
Forma Data" assuming the $10.00 per share purchase price as fair market value.
Actual expenses, however, may be higher or lower. For further discussion of
these plans, see "Management of Security Federal--Benefits."
Year 2000 data processing problems could interrupt and hurt Security Federal's
operations
Computer programs that use only two digits to identify a year could fail or
create erroneous results at or after the year 2000. A third party vendor
provides all core data processing applications to Security Federal. If the
vendor is unable to complete its year 2000 adjustments in a timely fashion, or
if it does not successfully make all the necessary year 2000 adjustments,
resulting computer malfunctions could interrupt the operations of Security
Federal and have a significant adverse impact on Security Federal's financial
condition and results of operations. For further discussion of Security
Federal's year 2000 compliance program, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Year 2000 Issues."
Security Federal's loan portfolio possesses increased risk due to Security
Federal's substantial number of consumer, multi-family and commercial real
estate, commercial business and residential construction loans, which may result
in an increase in non-performing loans and even loan losses
Security Federal's consumer, multi-family and commercial real estate,
commercial business and residential construction loans accounted for nearly one-
half of its total loan portfolio as of June 30, 1999. Generally, Security
Federal considers these types of loans to involve a higher degree of default
risk compared to first mortgage loans on one- to four-family owner occupied
residential properties. In addition, Security Federal plans to increase its
emphasis on consumer, commercial real estate and commercial business lending.
Because of Security Federal's planned increased emphasis on and increased
investment in consumer and commercial real estate and commercial business loans,
Security Federal may determine it necessary to increase the level of Security
Federal's provision for loan losses. Additional or increased provisions for loan
losses would hurt Security Federal's profits. For further information concerning
the risks associated with consumer, multi-family and commercial real estate,
commercial business and residential business loans, see "Business of Security
Federal--Lending Activities."
Rising interest rates could hurt Security Federal's profits
Like most financial institutions, Security Federal's ability to make a
profit depends largely on its net interest income, which is the difference
between interest income it receives from its loans and securities and interest
it pays on deposits and borrowings. A large percentage of Security Federal's
deposit liabilities have shorter maturities than those of its assets. Therefore,
if interest rates increase substantially, Security Federal anticipates that its
net interest income in the short term could be adversely affected as interest
earned on its assets would decrease more quickly than the interest paid on
deposits. For further discussion of how changes in interest rates could impact
Security Federal, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Management's Strategy" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Market
Risk Analysis."
11
Issuance of shares for benefit programs could reduce your ownership interest
If stockholders approve the new stock-based incentive plan, Security
Financial intends to issue shares and options to its officers and directors
through these plans. If the restricted stock awards under the stock-based
incentive plan are funded from authorized but unissued stock, your ownership
interest could be reduced by up to approximately 3.85%. If the options under the
stock-based incentive plan are granted from authorized but unissued stock, your
ownership interest could be reduced by up to approximately 9.09%. See "Pro Forma
Data" and "Management of Security Federal--Benefits."
Expected voting control by management and employees could enable insiders to
prevent a merger that may provide that shareholders receive a premium for their
shares
The shares of common stock that Security Federal's directors and executive
officers intend to purchase in the conversion, when combined with the shares
that may be awarded to participants under Security Federal's employee stock
ownership plan and Security Financial's stock-based incentive plan, could result
in management and employees controlling a significant percentage of Security
Financial's common stock. If these individuals were to act together, they could
have significant influence over the outcome of any stockholder vote. This voting
power may discourage takeover attempts you might like to see happen. In
addition, the total voting power of management and employees could reach in
excess of 20% of Security Financial's outstanding stock. That level would enable
management and employees as a group to defeat any stockholder matter that
requires an 80% vote, such as removal of directors, approval of certain business
combinations with interested shareholders and amendment of Security Financial's
Bylaws. In addition, an 80% vote is required to amend certain provisions of
Security Financial's Certificate of Incorporation, including the provisions
limiting voting rights and the provisions relating to approval of certain
business combinations, calling special meetings, the number and classification
of directors, director and officer indemnification by Security Financial and
amendment of Security Financial's Certificate of Incorporation and Bylaws. For
information about management's intended stock purchases and the number of shares
that may be awarded under new benefit plans, see "Management of Security
Federal--Executive Compensation," "Shares to Be Purchased by Management with
Subscription Rights" and "Restrictions on Acquisition of Security Financial."
Anti-takeover provisions and statutory provisions could make takeover attempts
that shareholders may want more difficult to achieve
Provisions in Security Financial's Certificate of Incorporation and Bylaws,
the corporate law of the State of Delaware, and federal regulations may make it
difficult and expensive to pursue a takeover attempt that management opposes.
These provisions may discourage or prevent takeover attempts you might like to
see happen. These provisions will also make the removal of the current board of
directors or management of Security Financial, or the appointment of new
directors, more difficult. These provisions include: limitations on voting
rights of beneficial owners of more than 10% of Security Financial's common
stock; supermajority voting requirements for certain business combinations; the
election of directors to staggered terms of three years; and the elimination of
cumulative voting for directors. The Certificate of Incorporation of Security
Financial also contains provisions regarding the timing and content of
stockholder proposals and nominations and limiting the calling of special
meetings. For further information about these provisions, see "Restrictions on
Acquisition of Security Financial."
Potential acquirers may be discouraged from pursuing the acquisition of Security
Financial because of the existence of the employment agreement and the severance
plan
The employment agreement to be entered into with the President and Chief
Executive Officer of Security Financial and Security Federal provide for cash
severance payments and/or the continuation of health, life and disability
benefits if the executive is terminated following a change in control of
Security Financial or Security Federal. If a change in control had occurred at
June 30, 1999, the aggregate value of the cash severance benefits available to
the President and Chief Executive Officer under the agreements would, based
solely on fiscal 1999 compensation data, have been approximately $525,000. In
addition, if a change in control had occurred at June 30, 1999 and all eligible
employees had been terminated, the aggregate payment due under the severance
plan would have been approximately $1.0 million. These estimates do not take
into account future salary adjustments or bonus
12
payments or the value of the continuation of other employee benefits. All of
these arrangements could have the effect of increasing the costs of acquiring
Security Financial, thereby discouraging future attempts to take over Security
Financial or Security Federal. For information about the proposed employment and
severance plan, see "Management of Security Federal--Executive Compensation."
Possible limited market for Security Financial's common stock could negatively
affect the market price
Although Security Financial has applied to receive preliminary approval to
list its common stock on the Nasdaq SmallCap Market, Security Financial does not
know whether an active trading market will develop. Because of the relatively
small size of this offering, you may not be able to sell all of your shares of
Security Financial on short notice and the sale of a large number of shares at
one time could temporarily depress the market price. Furthermore, Security
Financial cannot guarantee that if you purchase shares in the conversion you
will be able to sell your shares at or above the $10.00 purchase price. For
further information about the trading market for Security Financial's common
stock, see "Market for the Common Stock."
Banking reform legislation restricts the activities in which Security Financial
may engage compared to existing unitary holding companies
The U.S. Congress has enacted and the President is expected to sign
legislation intended to modernize the financial services industry. The
legislation provides for greater affiliations by commercial bank holding
companies with financial companies such as securities and insurance companies.
Under the legislation, newly formed unitary savings and loan holding companies
will not have the broad powers formerly available to unitary savings and loan
holding companies. Security Financial will be a unitary savings and loan holding
company after the conversion. Certain unitary savings and loan holding companies
would be grandfathered under the proposed legislation; however, Security
Financial will not qualify for the grandfathering. Consequently, Security
Financial will be restricted in terms of activities in which it may engage to a
greater extent than previously existing unitary savings and loan holding
companies. For example, Security Financial would not be permitted to engage in
commercial activities whereas a grandfathered unitary holding company would have
such authority.
13
SELECTED FINANCIAL INFORMATION
The following tables contain certain information concerning the financial
position and results of operations of Security Federal at the dates and for the
periods indicated. This information should be read in conjunction with the
Consolidated Financial Statements and related Notes at the back of this
prospectus.
At June 30,
-------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
SELECTED FINANCIAL DATA:
Total assets............................... $191,495 $288,078 $302,415
Cash and cash equivalents.................. 4,520 8,502 5,868
Loans held for sale........................ 3,430 49,487 14,529
Loans receivable, net...................... 148,316 180,845 252,208
Securities available for sale:
Mortgage-backed securities.............. 3,980 6,794 3,522
Investment securities................... 13,893 17,055 11,007
Deposits................................... 165,894 234,376 183,488
Total borrowings........................... 5,000 31,815 95,994
Total equity............................... 18,532 19,220 20,034
Year Ended June 30,
--------------------------------------
1999 1998 1997
------- -------- ---------
(In thousands)
SELECTED OPERATING DATA:
Total interest income...................... $ 17,779 $ 23,985 $ 18,867
Total interest expense..................... 9,424 15,466 10,887
-------- -------- ---------
Net interest income................... 8,355 8,519 7,980
Provision for loan losses.................. 750 550 333
-------- -------- ---------
Net interest income after
provision for loan losses................. 7,605 7,969 7,647
-------- -------- ---------
Noninterest income:
Loan servicing fees, net
of amortization...................... (516) (201) 1,368
Gain on sale of loans from secondary
marketing activities................. 1,527 2,138 642
Gain on sale of loans transferred
to held-for-sale..................... -- 1,632 --
Gain on sales of securities........... -- -- 270
Other noninterest income.............. 1,076 1,252 1,239
-------- -------- ---------
Total noninterest income......... 2,087 4,821 3,519
-------- -------- ---------
Noninterest expense:
Compensation and benefits............. 5,754 8,023 7,342
Other noninterest expense............. 4,546 5,601 5,665
-------- -------- ---------
Total noninterest expense........ 10,300 13,624 13,007
-------- -------- ---------
Loss before income taxes................... (608) (834) (1,841)
Income tax provision (benefit)............. -- -- (653)
-------- -------- ---------
Net loss................................... $ (608) $ (834) $ (1,188)
======== ======== =========
14
At June 30,
-------------------------------------
1999 1998 1997
------- -------- ---------
SELECTED OTHER DATA:
Number of:
Mortgage loans outstanding............................ 2,445 3,252 3,830
Deposit accounts...................................... 18,778 20,227 19,154
Full-service offices.................................. 7 7 8
At or For
the Year Ended June 30,
-------------------------------------
1999 1998 1997
------- -------- ---------
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios:
Return on assets (1).................................. (0.24)% (0.25)% (0.45)%
Return on equity (2).................................. (3.11) (4.08) (5.68)
Average interest rate spread (3)...................... 3.46 2.61 2.97
Interest rate spread at year end...................... 4.03 3.20 2.95
Net interest margin (4)............................... 3.64 2.76 3.27
Operating (noninterest) expense
to average total assets.............................. 4.10 4.08 4.92
Efficiency Ratio (5).................................. 98.64 102.13 113.11
Average interest-earning assets to average
interest-bearing liabilities......................... 104.47 102.88 106.83
Capital Ratios:
Tangible capital ratio................................ 9.63 6.69 6.60
Core capital ratio.................................... 9.63 6.69 6.60
Risk-based capital ratio.............................. 14.94 10.68 11.41
Ratio of average equity to average assets............. 7.78 6.13 7.90
Asset Quality Ratios:
Non-performing loans to total loans................... 1.41 1.61 2.12
Allowance for loan losses to non-performing
loans (6)............................................. 69.72 43.83 21.33
Allowance for loan losses to total loans.............. 0.98 0.71 0.45
__________________
(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income as a percentage of average interest-earning assets.
(5) Noninterest expense divided by the sum of net interest income and
noninterest income (excluding gain on sale of securities).
(6) Nonperforming loans consist of nonaccrual loans. See "Business of Security
Federal--Lending Activities--Nonperforming Assets and Delinquencies."
15
RECENT DEVELOPMENTS
The following tables contain certain information concerning the financial
position and results of operations of Security Federal at the date and for the
periods indicated. The data presented at September 30, 1999 and 1998 and for
the three month periods then ended are derived from unaudited condensed
consolidated financial statements but, in the opinion of management, reflects
all adjustments necessary to present fairly the results for these interim
periods. These adjustments consist only of normal recurring adjustments. The
results of operations for the three months ended September 30, 1999 are not
necessarily indicative of the results of operations that may be expected for the
year ending June 30, 2000.
At At
September 30, June 30,
1999 1999
------------- --------
(In thousands)
SELECTED FINANCIAL DATA:
Total assets......................... $190,970 $191,495
Cash and cash equivalents............ 4,453 4,520
Loans held for sale.................. 5,334 3,430
Loans receivable, net................ 143,209 148,316
Securities available for sale:
Mortgage-backed securities........ 3,595 3,980
Investment securities............. 13,757 13,893
Deposits............................. 163,711 165,894
Total borrowings..................... 5,000 5,000
Total equity......................... 18,758 18,532
For the Three Months
Ended September 30,
---------------------------
1999 1998
-------- -------
(In thousands)
SELECTED OPERATING DATA:
Total interest income..................................................... $ 3,480 $ 4,907
Total interest expense.................................................... 1,627 2,754
------- -------
Net interest income.................................................. 1,853 2,153
Provision for loan losses................................................. 75 125
------- -------
Net interest income after provision for loan losses....................... 1,778 2,028
------- -------
Noninterest income:
Loan servicing fees, net of amortization............................. 1 (223)
Gain on sale of loans from secondary marketing activities............ 60 631
Gain on sales of securities.......................................... -- --
Other noninterest income............................................. 417 342
------- -------
Total noninterest income........................................ 478 750
------- -------
Noninterest expense:
Compensation and benefits............................................ 966 1,750
Other noninterest expense............................................ 1,052 1,210
------- -------
Total noninterest expense....................................... 2,018 2,960
------- -------
Income (loss) before income taxes......................................... 238 (182)
Income tax provision (benefit)............................................ -- --
------- -------
Net income (loss)......................................................... $ 238 $ (182)
======= =======
16
At At
September 30, June 30,
1999 1999
------------ --------
(Dollars in thousands)
SELECTED OPERATING DATA:
Number of:
Mortgage loans outstanding....................................... 2,434 2,445
Deposit accounts................................................. 18,847 18,778
Full-service offices............................................. 7 7
At or For the
Three Months
Ended September 30,
-----------------------
1999 1998
------- -------
SELECTED FINANCIAL RATIOS AND OTHER DATA:
PERFORMANCE RATIOS:
Return on assets (1)........................................................ 0.49% (0.27)%
Return on equity (2)........................................................ 4.92 (3.69)
Average interest rate spread (3)............................................ 4.04 3.17
Interest rate spread at year end............................................ 4.10 3.45
Net interest margin (4)..................................................... 4.18 3.36
Operating (noninterest) expense to average total assets..................... 4.17 4.34
Efficiency Ratio (5)........................................................ 86.57 101.96
Average interest-earning assets to average interest-bearing liabilities..... 103.75 104.35
CAPITAL RATIOS:
Tangible capital ratio...................................................... 9.86 7.21
Core capital ratio.......................................................... 9.86 7.21
Risk-based capital ratio.................................................... 15.53 11.40
Ratio of average equity to average assets................................... 9.99 7.23
ASSET QUALITY RATIOS:
Non-performing loans to total loans......................................... 1.57 1.36
Allowance for loan losses to non-performing loans (6)....................... 64.92 48.35
Allowance for loan losses to total loans.................................... 1.02 0.66
_______________________
(1) Net income/(loss) divided by average total assets.
(2) Net income/(loss) divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income as a percentage of average interest-earning assets.
(5) Noninterest expense divided by the sum of net interest income and
noninterest income (excluding gain on sale of securities).
(6) Nonperforming loans consist of nonaccrual loans. See "Business of Security
Federal--Lending Activities--Nonperforming Assets and Delinquencies."
17
Comparison of Financial Condition at September 30, 1999 and June 30, 1999
Total assets decreased slightly to $191.0 million at September 30, 1999
from $191.5 million at June 30, 1999, or 0.3%. The decrease was primarily due to
loan repayments during the period of $5.1 million offset by additional
originations of loans held for sale of $1.9 million. The net cash inflows from
loan activity were used to reduce the balance of high-cost deposit accounts,
primarily municipal certificate of deposit accounts, by $2.2 million to $163.7
million at September 30, 1999 from $165.9 million at June 30, 1999. Borrowings
from the Federal Home Loan Bank remained unchanged at $5.0 million.
Total equity at September 30, 1999 was $18.7 million compared to $18.5
million at June 30, 1999 as a result of Security Federal's net income for the
three months ended September 30, 1999 of $238,000 offset by a $12,000 decline in
the fair value of securities available for sale.
Comparison of Operating Results for the Three Months Ended September 30, 1999
and 1998
General. Net income for the three month period ended September 30, 1999 was
$238,000 compared to a net loss of $182,000 for the comparable period in 1998,
an increase of $420,000. The increase was primarily attributable to an improved
net interest margin and reduced compensation and benefits associated with the
significant reduction in the number of personnel employed in loan servicing
operations. The loan servicing portion of the business was substantially
eliminated during 1999. In November 1999, Security Federal negotiated the
settlement of a lease commitment on property that Security Federal had
originally intended to use for a new branch office. Management anticipates that
Security Federal may incur some expense as a result of the settlement in the
second quarter of fiscal 2000; however, management expects that the expense
related to the settlement, if any, would not be material.
Interest Income. Interest income for the quarter ended September 30, 1999
was $3.5 million compared to $4.9 million for the quarter ended September 30,
1998, a decrease of $1.4 million, or 28.6%. The decrease was primarily
attributable to a decrease in the average balance of interest earning assets to
$177.5 million for the three months ended September 30, 1999 from $247.8 for the
same period in 1998 due primarily to loan sales in connection with Security
Federal's change in business strategy. The yield on interest earning assets
declined slightly to 7.84% for the three month period ended September 30, 1999
compared to 7.89% for the same period in 1998.
Interest Expense. Interest expense for the quarter ended September 30, 1999
was $1.6 million compared to $2.8 million for the same period in 1998. This
represents a decrease of $1.2 million, or 42.9%, which is attributable to a
decline in the average balance of interest bearing liabilities to $171.1 million
for the 1999 period from $237.4 million during the 1998 period. Accordingly, the
loan sale proceeds referred to above were used to reduce various high-cost
funding sources. The cost of funds fell to 3.80% for the three months ended
September 30, 1999 from 4.72% for the three months ended September 30, 1998. In
particular, the cost of certificate of deposit accounts declined to 4.88% from
5.68% during the comparable periods in 1999 and 1998. Additionally, the average
amount of borrowings declined to $5.0 million for the quarter ended September
30, 1999 from over $29.0 million for the quarter ended September 30, 1998, most
of which carried interest rates in excess of 6.10%.
Net Interest Income. Net interest income decreased to $1.9 million for the
three month period ended September 30, 1999 from $2.2 million, a decline of
$300,000, or 13.9%. The decrease was attributable to the decline in the levels
of interest-earning assets, which was offset by an improved net interest spread
which was 4.04% for the quarter ended September 30, 1999 compared to 3.17% for
the same period in 1998. The net interest margin also improved to 4.18% from
3.36% during the same periods. The increase in both the net interest spread and
margin are both attributable primarily to management's reduction of high cost
funding sources including negotiated rate certificates of deposit and
borrowings.
Provision for Loan Losses. The provision for loan losses was $75,000 for
the three months ended September 30, 1999 compared to $125,000 for the three
months ended September 30, 1998. This represents a decrease of $50,000, or
40.0%. Management increases the allowance for loan losses through a provision
charged to expense for loan growth based on a statistical percentage developed
considering past loss experiences, delinquency trends, general
18
economic conditions and other factors. Security Federal's loss experience has
declined slightly with net charge-offs of $30,000 for the quarter ended
September 30, 1999 compared to $68,000 for the quarter ended September 30, 1998.
Noninterest Income. Noninterest income was $478,000 for the three months
ended September 30, 1999 compared to $750,000 for the three month period ended
September 30, 1998, a decline of 272,000, or 36.3%. The decrease is primarily
attributable to a sharp reduction in the level of gains on sale of loans from
secondary market activities which fell to $60,000 for the quarter ended
September 30, 1999 from $631,000 for the same period in 1998. This decline was
partially offset by the elimination of loan servicing fees and related
amortization of mortgage servicing rights in 1999 compared to a net expense of
$223,000 for the three months ended September 30, 1998. The net expense amount
for the 1998 period was caused by a high volume of loan prepayments forcing
Security Federal to accelerate the amortization of mortgage servicing rights.
Additionally, other noninterest income improved to $417,000 for the 1999 period
from $342,000 in 1998. Both of these changes are attributable to the sale of
servicing rights in August 1999 related to $320 million of loans, resulting in a
net gain of $178,000. The sale substantially reduced Security Federal's loan
servicing operations and, therefore, the continuing expense from amortizing
mortgage servicing rights. Security Federal now sells mortgage loans on a
service-released basis.
Noninterest Expense. Noninterest expense for the quarter ended September
30, 1999 was $2.0 million compared to $3.0 million for the quarter ended
September 30, 1998, a decrease of $1.0 million, or 33.3%. The decline is
primarily attributable to a sharp reduction in compensation and benefits which
decreased to $966,000 for the three months ended September 30, 1999 from $1.75
million for the same period in 1998. The $784,000 decrease is related to the
substantial reduction in the number of employees during 1999 as part of
management's plan to reduce operating expenses and Security Federal's
discontinuation of loan servicing activities.
Income Taxes. There was no provision for income taxes for the three months
ended September 30,1999 due to the utilization of net operating loss
carryforwards. There was no provision for income taxes for the three months
ended September 30,1998 due to the operating loss during this period. Security
Federal had generated net operating losses in prior years which are being
carried forward and will be used to offset future tax liabilities until fully
utilized. Management anticipates that these carryforwards will be exhausted
during fiscal 2001.
19
USE OF PROCEEDS
The following table presents the estimated net proceeds of the offering,
the amount to be retained by Security Financial, the amount to be contributed to
Security Federal, and the amount of Security Financial's loan to the employee
stock ownership plan. See "Pro Forma Data" for the assumptions used to arrive at
these amounts.
1,572,500 Percentage 2,127,500 Percentage 2,446,625 Percentage
Shares at of Gross Shares at of Gross Shares at of Gross
$10.00 Proceeds of $10.00 Proceeds of $10.00 Proceeds of
Per Share $18,725,000 Per Share $21,175,000 Per Share $24,466,250
---------- ----------- ---------- ----------- ---------- -----------
(In thousands)
Gross proceeds.............................................. $ 15,725 100.00% $ 21,275 100.00% $ 24,466 100.00%
Less: estimated underwriting commissions and
other offering expenses............................... 654 9.16 723 3.40 762 3.12
---------- ------- ---------- ------- ---------- -------
Net offering proceeds....................................... 15,071 95.84 20,552 96.60 23,704 96.89
Less:
Proceeds to be contributed to Security Federal........... 7,536 47.92 10,276 48.30 11,852 48.44
Proceeds used for loan to employee stock ownership plan.. 1,258 8.00 1,702 8.00 1,957 8.00
---------- ------- ---------- ------- ---------- -------
Proceeds remaining for Security Financial................... $ 6,277 39.92% $ 8,574 40.30% $ 9,895 40.44%
========== ======= ========== ======= ========== =======
Security Financial may use the proceeds it retains from the offering:
. to invest in securities;
. to repurchase shares of its common stock;
. to finance the possible acquisition of financial institutions or other
businesses that are related to banking;
. for general corporate purposes; and
. to pay dividends to stockholders depending upon Security Financial's
operating performance and market conditions and other factors.
Security Federal may use the proceeds that it receives from the offering:
. to fund new loans;
. to invest in securities;
. to finance the possible expansion of its business activities; and
. for general corporate purposes.
Security Financial and Security Federal may need regulatory approvals to
engage in some of the activities listed above. See "Regulation and Supervision."
Neither Security Financial nor Security Federal currently has any specific plans
or agreements regarding any expansion activities or acquisitions.
20
Except as described above, neither Security Financial nor Security Federal
has any immediate specific use for the investment of the proceeds of this
offering. See "The Conversion--Reasons for the Conversion." Although Security
Federal's capital currently exceeds regulatory requirements, it is converting to
stock form primarily to structure itself in the form of organization used by
commercial banks and most other financial services companies. For a discussion
of management's business reasons for undertaking the conversion, see "The
Conversion--Reasons for the Conversion."
SECURITY FINANCIAL DIVIDEND POLICY
Security Financial's Board of Directors may adopt a policy of paying
regular cash dividends in the future, but has not decided the amount that may be
paid or when the payments may begin, if at all. In addition, the Board of
Directors may declare and pay periodic special cash dividends in addition to, or
in lieu of, regular cash dividends. In determining whether to declare or pay any
dividends, whether regular or special, the Board of Directors will take into
account the amount of the net proceeds retained by Security Financial, Security
Financial's financial condition, results of operations, tax considerations,
capital requirements, industry standards, and economic conditions. The
regulatory restrictions that affect the payment of dividends by Security Federal
to Security Financial discussed below will also be considered. Security
Financial cannot guarantee that it will pay dividends or that, if paid, that
Security Financial will not reduce or eliminate dividends in the future.
Security Financial is subject to Delaware law, which generally limits
dividends to an amount equal to the difference between the amount by which total
assets exceed total liabilities and the amount equal to the aggregate par value
of the outstanding shares of capital stock. If there is no difference between
these amounts, dividends are limited to net income for the current and/or
immediately preceding fiscal year.
Dividends from Security Financial may depend, in part, upon receipt of
dividends from Security Federal because Security Financial initially will have
no source of income other than dividends from Security Federal and earnings from
the investment of the net proceeds from the offering retained by Security
Financial. Office of Thrift Supervision regulations limit distributions from
Security Federal to Security Financial. In addition, Security Federal may not
declare or pay a cash dividend on its capital stock if its effect would be to
reduce the regulatory capital of Security Federal below the amount required for
the liquidation account to be established as required by Security Federal's plan
of conversion. See "Regulation and Supervision--Federal Savings Institution
Regulation--Limitations on Capital Distributions," "The Conversion--Effects of
Conversion to Stock Form--Liquidation Account" and Note 15 of the Notes to
Consolidated Financial Statements included in the back of this prospectus.
Any payment of dividends by Security Federal to Security Financial that
would be deemed to be drawn out of Security Federal's bad debt reserves would
require the payment of federal income taxes by Security Federal at the then
current income tax rate on the amount deemed distributed. See "Federal and State
Taxation of Income--Federal Taxation" and Note 11 of the Notes to Consolidated
Financial Statements included in this prospectus. Security Financial does not
contemplate any distribution by Security Federal that would result in this type
of tax liability.
Additionally, Security Financial and Security Federal have committed to the
Office of Thrift Supervision that during the one-year period following the
conversion Security Financial will not take any action to declare an
extraordinary dividend to stockholders that would be treated by recipients as a
tax-free return of capital for federal income tax purposes.
21
MARKET FOR THE COMMON STOCK
Security Financial has not previously issued common stock and there is
currently no established market for the common stock. Security Financial has
applied to receive conditional approval to have its common stock quoted on the
Nasdaq SmallCap Market under the symbol "SFBI" after the conversion. One of the
requirements for continued quotation of the common stock on the Nasdaq SmallCap
Market is that there be at least three market makers for the common stock. KBW
has advised Security Financial that it intends to make a market in the common
stock following the conversion, but is under no obligation to do so. Security
Financial will seek to encourage and assist at least two additional market
makers to make a market in the common stock. If Security Financial, after the
conversion, qualifies to be listed on The Nasdaq National Market, it will take
steps to do so.
Making a market involves maintaining bid and asked quotations and being
able, as principal, to effect transactions in reasonable quantities at those
quoted prices. Various securities laws and other regulatory requirements apply
to these activities. While Security Financial believes that there will be other
broker-dealers to act as market makers for the common stock, Security Financial
cannot guarantee that there will be three or more market makers for the common
stock.
Additionally, the development of a liquid public market depends on the
existence of willing buyers and sellers, the presence of which is not within
Security Financial's control or under the control of any market maker. The
number of active buyers and sellers of the common stock at any particular time
may be limited. Under such circumstances, you could have difficulty selling your
shares on short notice and therefore you should not view the common stock as a
short-term investment. Security Financial cannot assure you that an active and
liquid trading market for the common stock will develop or that, if it develops,
it will continue, nor can Security Financial assure you that if you purchase
shares you will be able to sell them at or above $10.00 per share or that
quotations will be available on the Nasdaq SmallCap Market as contemplated.
22
CAPITALIZATION
The following table presents the historical capitalization of Security
Federal at June 30, 1999, and the pro forma capitalization of Security Financial
after giving effect to the assumptions listed under "Pro Forma Data," based on
the sale of the number of shares of common stock indicated in the table. The
issuance of 2,446,625 shares would require Office of Thrift Supervision approval
of an updated appraisal confirming that valuation. This table does not reflect
the issuance of additional shares under the proposed stock-based incentive plan.
A change in the number of shares to be issued in the conversion may materially
affect pro forma capitalization.
Security Financial
Pro Forma Capitalization
Based Upon the Sale of
-----------------------------------------------
15% Above
Minimum of Maximum of Maximum of
Estimated Estimated Estimated
Valuation Valuation Valuation
Range Range Range
---------- ----------- ----------
Security Federal 1,572,500 2,127,500 2,446,625
Capitalization Shares at Shares at Shares at
as of $10.00 $10.00 $10.00
June 30, 1999 Per Share Per Share Per Share
------------- ---------- ----------- ----------
(In thousands)
Deposits (1).......................................... $ 165,894 $ 165,894 $ 165,894 $ 165,894
Federal Home Loan Bank advances....................... 5,000 5,000 5,000 5,000
--------- ---------- ---------- ----------
Total deposits and borrowed funds..................... $ 170,894 $ 170,894 $ 170,894 $ 170,894
========= ========== ========== ==========
Stockholders' equity:
Preferred stock:
1,000,000 shares, $.01 par value per share,
authorized; none issued or outstanding....... -- -- -- --
Common stock:
4,000,000, $.01 par value per share,
authorized; specified number of shares
assumed to be issued and outstanding......... -- 16 21 24
Additional paid-in capital............................ -- 15,055 20,531 23,680
Retained earnings (2)................................. 18,592 18,592 18,592 18,592
Accumulated other comprehensive income................ (60) (60) (60) (60)
Less:
Common stock acquired by employee
stock ownership plan (3)........................ -- 1,258 1,702 1,957
Common stock to be acquired by management
development and recognition plan (4)............ -- 629 851 979
--------- ---------- ---------- ----------
Total stockholders' equity............................ $ 18,532 $ 31,716 $ 36,531 $ 39,300
========= ========== ========== ==========
______________________________
(1) Withdrawals from deposit accounts for the purchase of common stock are not
reflected. Withdrawals to purchase common stock will reduce pro forma
deposits by the amounts of the withdrawals.
(2) Retained earnings are substantially restricted by applicable regulatory
capital requirements. Additionally, Security Federal will be prohibited from
paying any dividend that would reduce its regulatory capital below the
amount in the liquidation account, which will be established for the benefit
of Security Federal's eligible depositors as of June 30, 1998 and September
30, 1999, at the time of the conversion and decreased subsequently as these
account holders reduce their balances or cease to be depositors. See "The
Conversion--Effects of Conversion to Stock Form--Liquidation Account."
(3) Assumes that 8% of the common stock sold in the conversion will be acquired
by the ESOP in the conversion with funds borrowed from Security Financial.
Under generally accepted accounting principles, the amount of common stock
to be purchased by the ESOP represents unearned compensation and is,
accordingly, reflected as a reduction of capital. As shares are released to
ESOP participants' accounts, a corresponding reduction in the charge against
capital will occur. Since the funds are borrowed from Security Financial,
the borrowing will be eliminated in consolidation and no liability or
interest expense will be reflected in the consolidated financial statements
of Security Financial. See "Management of Security Federal--Benefits--
Employee Stock Ownership Plan."
(4) Assumes the purchase in the open market at $10.00 per share, under the
proposed stock-based incentive plan, of a number of shares equal to 4% of
the shares of common stock issued in the conversion at the minimum, maximum
and 15% above the maximum of the estimated valuation range. The shares are
reflected as a reduction of stockholders' equity. See "Risk Factors--
Issuance of Shares for Benefit Programs Could Reduce Your Ownership
Interest," "Pro Forma Data" and "Management of Security Federal--Benefits--
Stock-Based Incentive Plan." The stock-based incentive plan will require
stockholder approval at a meeting following the conversion, which may not be
held less than six months after the completion of the conversion.
23
HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE
The following table presents Security Federal's historical and pro forma
capital position relative to its capital requirements at June 30, 1999. The
amount of capital infused into Security Federal for purposes of the following
table is 50% of the net proceeds of the offering. For purposes of the table, the
amount expected to be borrowed by the employee stock ownership plan and the cost
of the shares expected to be acquired by the stock-based incentive plan are
deducted from pro forma regulatory capital. For a discussion of the assumptions
underlying the pro forma capital calculations presented below, see "Use of
Proceeds," "Capitalization" and "Pro Forma Data." The definitions of the terms
used in the table are those provided in the capital regulations issued by the
Office of Thrift Supervision. For a discussion of the capital standards
applicable to Security Federal, see "Regulation and Supervision--Federal Savings
Institution Regulation--Capital Requirements."
Pro Forma at June 30, 1999
------------------------------------------------------------------
15% Above
Minimum of Maximum of Maximum of
Estimated Estimated Estimated
Valuation Range Valuation Range Valuation Range
-------------------- -------------------- -------------------
Historical at 1,572,500 Shares 2,127,500 Shares 2,446,625 Shares
June 30, 1999, at $10.00 Per Share at $10.00 Per Share at $10.00 Per Share
------------------- -------------------- -------------------- -------------------
Percent of Percent of Percent of Percent of
Adjusted Adjusted Adjusted Adjusted
Total Total Total Total
Amount Assets (1) Amount Assets (1) Amount Assets (1) Amount Assets (1)
-------- ---------- ------- ---------- ------- ---------- ------- ----------
(Dollars in thousands)
Equity under generally accepted
accounting principles (2)............ $18,532 9.7% $24,181 12.3% $26,255 13.2% $27,448 13.7%
======= ======= ======= =======
Tangible capital (2).................... $18,498 9.6% $24,147 12.2% $26,221 13.1% $27,414 13.6%
Tangible capital requirement............ 2,881 1.5 2,966 1.5 2,997 1.5 3,015 1.5
------- ---- ------- ---- ------- ---- ------- ----
Excess.................................. $15,617 8.1% $21,181 10.7% $23,224 11.6% $24,399 12.1%
======= ==== ======= ==== ======= ==== ======= ====
Core capital (2)........................ $18,498 9.6% $24,147 12.2% $26,221 13.1% $27,414 13.6%
Core capital requirement................ 7,684 4.0 7,910 4.0 7,993 4.0 8,040 4.0
------- ---- ------- ---- ------- ---- ------- ----
Excess.................................. $10,814 5.6% $16,237 8.2% $18,228 9.1% $19,374 9.6%
======= ==== ======= ==== ======= ==== ======= ====
Total risk-based capital (3)............ $19,757 14.9% $25,406 19.1% $27,480 20.5% $28,673 21.4%
Total risk-based capital requirement.... 10,579 8.0 10,669 8.0 10,702 8.0 10,721 8.0
------- ---- ------- ---- ------- ---- ------- ----
Excess.................................. $ 9,178 6.9% $14,737 11.1% $16,778 12.5% $17,952 13.4%
======= ==== ======= ==== ======= ==== ======= ====
_________________________________
(1) Tangible capital levels and core capital levels are shown as a percentage of
adjusted total assets of $191.5 million. Risk-based capital levels are
shown as a percentage of risk-weighted assets of $132.2 million.
(2) Unrealized gains and losses on securities available-for-sale and disallowed
investment in loan servicing assets account for the difference between
generally accepted accounting principles capital and each of tangible
capital and core capital. See Note 12 to Notes to Consolidated Financial
Statements for additional information.
(3) Percentage represents total core and supplementary capital divided by total
risk-weighted assets. Assumes net proceeds are invested in assets that
carry a 20% risk-weighting.
24
PRO FORMA DATA
The plan of conversion requires that the common stock must be sold at a
price equal to the estimated market value of Security Financial and Security
Federal, as converted, based upon an independent appraisal. The estimated
valuation range as of October 20, 1999, is from a minimum of $15,725,000 to a
maximum of $21,275,000 with a midpoint of $18,500,000. At a price per share of
$10.00, this results in a minimum number of shares of 1,572,500, a maximum
number of shares of 2,127,500 and a midpoint number of shares of 1,850,000.
The actual net proceeds from the sale of the common stock cannot be
determined until the conversion is completed. However, net proceeds indicated in
the following table are based upon the following assumptions:
. Webb will receive a management fee of $25,000 and a success fee of
1.35% of the aggregate purchase price of the shares sold in the
offering, excluding shares purchased by the ESOP and officers,
directors and employees of Security Federal, or members of their
immediate families. See "The Conversion--Plan of Distribution for the
Subscription, Direct Community and Syndicated Community Offerings");
. Conversion expenses, excluding the fees paid to Webb, will total
approximately $450,000 regardless of the number of shares sold in the
conversion; and
Actual expenses may vary from this estimate, and the fees paid will depend
upon whether a syndicate of broker-dealers or other means is necessary to sell
the shares, and other factors.
Pro forma net income has been calculated as if the conversion were
completed on July 1, 1998 and the estimated net proceeds had been invested at
5.15% beginning on that date, which represents the one-year U.S. Treasury Bill
yield as of June 30, 1999. In light of changes in interest rates in recent
periods, Security Financial and Security Federal believe that the one-year U.S.
Treasury Bill yield more accurately reflects pro forma reinvestment rates than
the arithmetic average method called for by Office of Thrift Supervision
regulations.
A pro forma after-tax return of 5.5% is used for both Security Financial
and Security Federal after giving effect to a combined federal and state income
tax rate of 0.0% due to Security Federal's net operating loss carryovers. The
losses may expire in 2013 and are expected to be utilized before the end of
fiscal year ended June 30, 2001. Thereafter, however, Security Federal expects
to be taxed at the normal federal and state tax rates. Historical and pro forma
per share amounts have been calculated by dividing historical and pro forma
amounts by the number of shares of common stock indicated in the table.
When reviewing the following table you should consider the following:
. The final column gives effect to the sale of an additional 319,125
shares in the conversion, which may be issued without any further
notice if Keller & Company increases its appraisal to reflect the
results of this offering or changes in the financial condition or
results of operations of Security Federal or changes in market
conditions after the offering begins. See "The Conversion--Stock
Pricing and Number of Shares to be Issued."
. Since funds on deposit at Security Federal may be withdrawn to
purchase shares of common stock, the amount of funds available for
investment will be reduced by the amount of withdrawals for stock
purchases. The pro forma table does not reflect withdrawals from
deposit accounts.
. Historical per share amounts have been computed as if the shares of
common stock expected to be issued in the conversion had been
outstanding at July 1, 1998. However, neither historical nor pro forma
stockholders' equity has been adjusted to reflect the investment of
the estimated net proceeds of the sale of the shares in the
conversion, the additional employee stock ownership plan expense or
the proposed stock-based incentive plan expense.
25
. Pro forma stockholders equity ("book value") represents the difference
between the stated amounts of Security Federal's assets and
liabilities. The amounts shown do not reflect the liquidation account,
which will be established for the benefit of eligible depositors as of
June 30, 1998 and September 30, 1999, or the federal income tax
consequences of the restoration to income of Security Federal's
special bad debt reserves for income tax purposes, which would be
required in the unlikely event of liquidation. See "The Conversion--
Effects of Conversion to Stock Form" and "Federal and State Taxation."
The amounts shown for book value do not represent fair market values
or amounts available for distribution to stockholders in the unlikely
event of liquidation.
. The amounts shown as pro forma stockholders' equity per share do not
represent possible future price appreciation or depreciation of
Security Financial's common stock.
. The amounts shown do not account for the shares to be reserved for
issuance under the stock-based incentive plan, which requires
stockholder approval at a meeting following the conversion. Recently
proposed accounting rules would require Security Financial to
recognize compensation expense for stock options awarded to
nonemployee directors.
The following pro forma data, which is based on Security Federal's equity
at June 30, 1999 and net income for the fiscal year ended June 30, 1999, may not
represent the actual financial effects of the conversion or the operating
results of Security Financial after the conversion. The pro forma data rely
exclusively on the assumptions outlined above. The pro forma data does not
represent the fair market value of Security Financial's common stock, the
current fair market value of Security Federal's or Security Financial's assets
or liabilities, or the amount of money that would be available for distribution
to shareholders if Security Financial is liquidated after the conversion.
26
At or For the Year Ended June 30, 1999
--------------------------------------------------------
1,572,500 2,127,500 2,446,625
Shares Sold Shares Sold Shares Sold
at $10.00 at $10.00 at $10.00
Per Share Per Share Per Share
(Minimum (Maximum (Maximum,
of Range) of Range) as Adjusted)
----------- ----------- -----------
(Dollars in thousands, except per share amounts)
Pro forma market capitalization........................... $ 15,725 $ 21,275 $ 24,466
Less offering expenses.................................... (654) (723) (762)
----------- ----------- -----------
Estimated net conversion proceeds...................... 15,071 20,552 23,704
Less ESOP shares.......................................... (1,258) (1,702) (1,957)
Less RRP shares........................................... (629) (851) (979)
----------- ----------- -----------
Estimated proceeds available for investment............ $ 13,184 $ 17,999 $ 20,768
=========== =========== ===========
Consolidated net income:
Historical............................................. $ (608) $ (608) $ (608)
Pro forma adjustments:
Net income from proceeds............................ 679 927 1,070
ESOP................................................ (84) (113) (130)
RRP................................................. (126) (170) (196)
----------- ----------- -----------
Pro forma net income (loss)...................... $ (139) $ 36 $ 136
=========== =========== ===========
Net income per share:
Historical............................................. $ (0.42) $ (0.31) $ (0.27)
Pro forma adjustments:
Net income from proceeds............................ 0.47 0.47 0.47
ESOP................................................ (0.06) (0.06) (0.06)
RRP................................................. (0.09) (0.09) (0.09)
----------- ----------- -----------
Pro forma net income (loss)...................... $ (0.10) $ 0.01 $ 0.05
=========== =========== ===========
Pro forma price to earnings per share (P/E ratio)......... (100.00)x 1,000.00x 200.00x
Stockholders' equity:
Historical (retained earnings)......................... $ 18,532 $ 18,532 $ 18,532
Estimated net conversion proceeds...................... 15,071 20,552 23,704
Less: common stock acquired by:
ESOP................................................ (1,258) (1,702) (1,957)
RRP................................................. (629) (851) (979)
----------- ----------- -----------
Pro forma stockholders' equity................... $ 31,716 $ 36,531 $ 39,300
=========== =========== ===========
Stockholders' equity per share:
Historical............................................. $ 11.79 $ 8.71 $ 7.57
Estimated net conversion proceeds...................... 9.58 9.66 9.69
Less: common stock acquired by:
ESOP................................................ (0.80) (0.80) (0.80)
RRP................................................. (0.40) (0.40) (0.40)
----------- ----------- -----------
Pro forma stockholders' equity per share......... $ 20.17 $ 17.17 $ 16.06
=========== =========== ===========
Pro forma price to book value............................. 49.58% 58.24% 62.27%
Number of shares.......................................... 1,572,500 2,127,500 2,446,625
27
_____________________________
(1) Assumes that the employee stock ownership plan will purchase 8% of the
shares of common stock offered in the conversion. The employee stock
ownership plan will borrow the funds used to acquire these shares from the
net proceeds from the conversion retained by Security Financial. The amount
of this borrowing, which will have an interest rate equal to the prime rate
as published in The Wall Street Journal, which is currently 8.25%, has been
reflected as a reduction from gross proceeds to determine estimated net
investable proceeds. Security Federal intends to make contributions to the
employee stock ownership plan in amounts at least equal to the principal and
interest requirement of the debt. As the debt is paid down, stockholders'
equity will be increased. Security Federal's payment of the employee stock
ownership plan debt is based upon equal installments of principal and
interest over a 15-year period, assuming a combined federal and state income
tax rate of 0%, due to Security Federal's net operating loss carryovers.
Interest income earned by Security Financial on the employee stock ownership
plan debt offsets the interest paid by Security Federal on the employee
stock ownership plan loan. No reinvestment is assumed on proceeds
contributed to fund the employee stock ownership plan. Applicable accounting
practices require that compensation expense for the employee stock ownership
plan be based upon shares committed to be released and that unallocated
shares be excluded from earnings per share computations. The valuation of
shares committed to be released would be based upon the average market value
of the shares during the year, which, for purposes of this calculation, was
assumed to be equal to the $10.00 per share purchase price. See "Management
of Security Federal--Benefits--Employee Stock Ownership Plan."
(2) In calculating the pro forma effect of the stock-based incentive plan, it is
assumed that the required stockholder approval has been received, that the
shares were acquired by the stock-based incentive plan on July 1, 1998 in
open market purchases at the $10.00 per share purchase price, that 20% of
the amount contributed was an amortized expense during the period, and that
the combined federal and state income tax rate is 0%, due to Security
Federal's net operating loss carryovers. The issuance of authorized but
unissued shares of the common stock instead of open market purchases would
dilute the voting interests of existing stockholders by approximately 3.85%.
For purposes of this table, shares issued under the stock-based incentive
plan vest 20% per year and compensation expense is recognized on a straight-
line basis over each vesting period. If the fair market value per share is
greater than $10.00 per share on the date shares are awarded under the
stock-based incentive plan, total stock-based incentive plan expense would
be greater. The total estimated stock-based incentive plan expense was
multiplied by 20%, which is the total percent of shares for which expense is
recognized in the first year.
The following table shows what pro forma net income and stockholders' equity
per share would be if shares for the stock-based incentive plan were
authorized but unissued shares instead of repurchased shares. The table also
shows pre-tax stock-based incentive plan expense.
15% Above
Minimum Maximum Maximum
of of of
Estimated Estimated Estimated
Valuation Valuation Valuation
Range Range Range
--------- --------- ---------
Pro forma net income per share:
Fiscal year ended June 30, 1999.............. $ (0.07) $ 0.04 $ 0.08
Pro forma stockholders' equity per share:
At June 30, 1999............................. $ 19.78 $ 16.90 $ 15.83
Pre-tax stock-based incentive plan expense:
Fiscal year ended June 30, 1999.............. $ 125,800 $ 170,200 $ 195,730
28
SHARES TO BE PURCHASED BY MANAGEMENT WITH SUBSCRIPTION RIGHTS
The following table presents certain information as to the approximate
purchases of common stock by each director and executive officer of Security
Federal, including their associates, as defined by applicable regulations. No
individual has entered into a binding agreement to purchase these shares and,
therefore, actual purchases could be more or less than indicated. Directors and
executive officers and their associates may not purchase more than 31% of the
shares sold in the conversion. For purposes of the following table, sufficient
shares are assumed to be available to satisfy subscriptions in all categories.
Directors, executive officers, their associates, and employees of Security
Financial and Security Federal will pay the same price as all other subscribers
for the shares for which they subscribe.
Percent of Percent of
Anticipated Anticipated Shares at Shares at
Number of Dollar Minimum Maximum
Shares to be Amount to be of Estimated of Estimated
Name and Position Purchased(1) Purchased(1) Valuation Range Valuation Range
- ------------------ ------------- ------------- --------------- ---------------
Mary Beth Bonaventura................................. 10,000 $ 100,000 0.64% 0.47%
Chairman of the Board
Lawrence R. Parducci.................................. 20,000 200,000 1.27 0.94
Vice Chairman of the Board
John P. Hyland........................................ 20,000 200,000 1.27 0.94
Director, President and Chief Executive Officer
Howard O. Cyrus....................................... 2,000 20,000 0.12 0.09
Director
Dr. Peter Ferrini..................................... 20,000 200,000 1.27 0.94
Director
Tula Kavadias......................................... 10,000 100,000 0.64 0.47
Director
Philip T. Rueth....................................... 10,000 100,000 0.64 0.47
Director
Robert Lauer.......................................... 10,000 100,000 0.64 0.47
Director
Robert Vellutini...................................... 10,000 100,000 0.64 0.47
Director
All other Executive Officers
as a group (7 persons)............................. 19,600 196,000 1.24 0.93
------- ----------- ---- ----
All Directors and Executive Officers
as a group (16 persons)............................ 131,600 $ 1,316,000 8.37% 6.19%
___________________
(1) Does not include any shares to be awarded under the employee stock ownership
plan and stock-based incentive plan or options to acquire shares under the
stock-based incentive plan.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
Security Federal is engaged primarily in attracting deposits from the
general public and using such deposits to fund originations of one- to-four-
family residential mortgage loans, consumer loans, including home equity and
second mortgage loans, and multi-family and commercial real estate loans, and
other loans primarily in its market areas, and, to a substantially lesser
extent, to acquire securities. Security Federal's revenues historically have
been derived principally from interest earned on loans and securities, and gains
from sales of first mortgage loans in the secondary market and fees from the
servicing of first mortgage loans. The operations of Security Federal are
influenced significantly by general economic conditions and by policies of
financial institution regulatory agencies, primarily the Office of Thrift
Supervision and the Federal Deposit Insurance Corporation. Security Federal's
cost of funds is influenced by interest rates on competing investments and
general market interest rates. Lending activities and mortgage loan sales
volumes are affected by the demand for financing of real estate and other types
of loans, which in turn is affected by the interest rates at which such
financings may be offered.
Security Federal's net interest income is dependent primarily upon the
difference or spread between the average yield earned on loans receivable and
securities and the average rate paid on deposits, as well as the relative
amounts of such assets and liabilities. Security Federal, like other thrift
institutions, is subject to interest rate risk to the degree that its interest-
bearing liabilities mature or reprice at different times, or on a different
basis, than its interest-earning assets.
Management's Strategy
Recent History of Management's Strategy. In 1996, Security Federal began
pursuing a strategic plan to increase its asset size largely through expansion
of its mortgage loan origination and mortgage banking operations, which included
the origination and purchase of loans for sale in the secondary mortgage market,
which if sold, were sold with loan servicing retained. At June 30, 1998,
Security Federal's portfolio of loans serviced for others totalled $1.04
billion. Assets increased from $252.5 million, to $302.4 million from June 30,
1996 to June 30, 1997. The growth was initially funded through FHLB borrowings
until the borrowing limit was reached. At that point, Security Federal resorted
to attracting greater deposits. By competing for deposits with above-market
rates, Security Federal dramatically increased interest expense. Interest
expense increased from $10.9 million for the fiscal year ended June 30, 1997 to
$15.5 million for the fiscal year ended June 30, 1998. Furthermore, the
decision to pursue an aggressive growth strategy dramatically increased non-
interest expense due to, among other things, an increase in employees, which
created a corresponding increase in compensation expense and other operating
expenses. Non-interest expense increased by $617,000 from the fiscal year ended
June 30, 1997 to the fiscal year ended June 30, 1998. The income produced by
Security Federal's mortgage banking activities, including its loan sale and
servicing operations, was not sufficient to cover the increased expense of these
activities. Consequently, Security Federal began experiencing losses.
Specifically, Security Federal experienced net losses of $1.2 million, $834,000
and $608,000 for each of the three fiscal years ended June 30, 1997, 1998 and
1999, respectively.
In 1998, the Board of Directors decided that the aggressive growth strategy
should be abandoned. John P. Hyland was hired as President and Chief Executive
Officer in October 1998 and began addressing ways in which both interest and
non-interest expenses could be reduced. Security Federal reduced assets from
$355.4 million at December 31, 1997 to $288.1 million at June 30, 1998 and to
$191.5 million at June 30, 1999, substantially through the sale of loans.
Additionally, Security Federal sold substantially all of its servicing rights
related to loans serviced for others. This enabled management to address means
to cut expenses by reducing costs related to its former loan servicing
operations, including reductions in staff and various other expenses. Non-
interest expense decreased by $3.3 million from $13.6 million for the fiscal
year ended June 30, 1998 to $10.3 million for the fiscal year ended June 30,
1999. Furthermore, the reduction in the mortgage banking activities reduced the
pressure on Security Federal to seek sources of funds. Security Federal greatly
reduced interest expense by reducing high interest certificates of deposit and
borrowings. As a result, interest expense related to deposits decreased from
$10.8 million to $7.9 million for the fiscal years ended June 30, 1998 to June
30, 1999, respectively, and interest expense related to borrowed funds decreased
from $4.6 million to $1.6 million for the same corresponding periods.
30
Current Business Strategy. Security Federal's current strategic plan is to
enhance profitability through increasing interest income as well as non-interest
income, while managing growth, maintaining asset quality and reducing expenses.
Management seeks to accomplish these goals by emphasizing its retail banking
services through its network of branch offices. Security Federal seeks to
obtain high quality residential, home equity and second mortgage loans by
maintaining a high level of local visibility and offering a high level of
customer service. Security Federal is also seeking high quality commercial real
estate loans, a variety of consumer loans, commercial business loans and
construction loans, which will yield higher returns, in the communities it
serves as market conditions permit. Additionally, as part of its mortgage
banking operations, Security Federal has established strong relationships with a
number of correspondent banks and mortgage brokers which generate a significant
volume of loan originations. Security Federal intends to continue its mortgage
banking operations, although all loans sold will be sold with servicing
released, which management believes will increase its non-interest income and
reduce interest rate risk. Adjustable-rate mortgage loans and 15-year fixed-
rate loans will be retained, while most longer-term fixed-rate loans will be
sold in the secondary market.
Security Federal continues to seek means to reduce expenses. Although
compensation expense has been substantially reduced through the elimination of
66 staff members and streamlined operating procedures, additional reductions may
occur as a result of Security Federal's decision to eliminate its loan servicing
operation. Furthermore, the reduction in staff that has already occurred has
resulted in additional savings in employee benefits and pension expense, as well
as the expense of software and data processing related to the loan servicing
operations. Management is reviewing opportunities for further cost reductions
in those, as well as other, areas. While management is considering branching
opportunities, including, possibly into the Chicago area, management intends to
evaluate the cost of any expansion strategy and to continue to reduce operating
costs at its current seven branch offices.
Management has also addressed interest expense and intends to continue to
build and maintain non-certificate accounts, including business checking,
consumer checking and other related accounts. These accounts generally carry
lower costs than certificate accounts and are believed to represent primarily
"core" deposits that are less vulnerable to interest rate changes (and
competition from other financial products) than certificate accounts.
Market Risk Analysis
General. Security Federal's profitability depends primarily on its net
interest income, which is the difference between the income it receives on its
loan and investment portfolio and its cost of funds, which consists of interest
paid on deposits and borrowings. Net interest income is also affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. Security
Federal's profitability is also affected by the level of income and expenses.
Noninterest income includes service charges and fees and gain on sale of
investments. Noninterest expenses primarily include compensation and benefits,
occupancy and equipment expenses, deposit insurance premiums and data processing
expenses. Security Federal's results of operations are also significantly
affected by general economic and competitive conditions, particularly changes in
market interest rates, government legislation and regulation and monetary and
fiscal policies.
Qualitative Aspects of Market Risk. In an attempt to manage its exposure
to changes in interest rates, management monitors Security Federal's interest
rate risk. The Board of Directors reviews at least quarterly Security Federal's
interest rate risk position and profitability. The Board of Directors also
reviews Security Federal's portfolio, formulates investment strategies and
oversees the timing and implementation of transactions to assure attainment of
Security Federal's objectives in the most effective manner. In addition, the
Board reviews on a quarterly basis Security Federal's asset/liability position,
including simulations of the effect on Security Federal's capital of various
interest rate scenarios.
In managing its asset/liability mix, Security Federal, depending on the
relationship between long- and short-term interest rates, market conditions and
consumer preference, often places more emphasis on managing short-term net
interest margin than on better matching the interest rate sensitivity of its
assets and liabilities in an effort to enhance net interest income. Management
believes that the increased net interest income resulting from a mismatch in the
31
maturity of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide high enough returns to justify the increased
exposure to sudden and unexpected increases in interest rates.
The Board has taken a number of steps to manage Security Federal's
vulnerability to changes in interest rates. First, Security Federal uses
customer service and marketing efforts to increase Security Federal's non-
certificate accounts. At June 30, 1999, $66.3 million or 40.0% of Security
Federal's deposits consisted of passbook, NOW and money market accounts.
Security Federal believes that these accounts represent "core" deposits which
are generally somewhat less interest rate sensitive than other types of deposit
accounts. Second, while Security Federal continues to originate 30 year fixed
rate residential loans, all such loans are sold in the secondary market.
Currently, over 37.2% of Security Federal's loans consist of adjustable rate
first mortgage loans and home equity lines of credit, which also carry
adjustable interest rates. Finally, Security Federal has focused a significant
portion of its investment activities on securities with terms of five years or
less. At June 30, 1999, $14.0 million or 77.9% of Security Federal's securities
had terms to maturity of five years or less based on their carrying value in
addition to Security Federal's mortgage-backed securities which provide for
regular principal repayments.
In order to encourage institutions to reduce their interest rate risk, the
Office of Thrift Supervision adopted a rule incorporating an interest rate risk
component into the risk-based capital rules. Using data compiled by the Office
of Thrift Supervision, Security Federal receives a report which measures
interest rate risk by modeling the change in net portfolio value over a variety
of interest rate scenarios. This procedure for measuring interest rate risk was
developed by the Office of Thrift Supervision to replace the "gap" analysis,
which is the difference between interest-earning assets and interest-bearing
liabilities that mature or reprice within a specific time period. Net portfolio
value is the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The calculation is intended to illustrate the
change in net portfolio value that will occur upon an immediate change in
interest rates of at least 200 basis points with no effect given to any steps
that management might take to counter the effect of that interest rate movement.
Under Office of Thrift Supervision regulations, an institution with a greater
than "normal" level of interest rate risk must take a deduction from total
capital for purposes of calculating its risk-based capital. The Office of Thrift
Supervision, however, has delayed the implementation of this regulation. An
institution with a "normal" level of interest rate risk is defined as one whose
"measured interest rate risk" is less than 2.0%. Institutions with assets of
less than $300 million and a risk-based capital ratio of more than 12.0% are
exempt. Security Federal is exempt because of its asset size and it has greater
than 12% risk-based capital. If the proposed regulation was implemented and
applied at June 30, 1999, Security Federal believes that its level of interest
rate risk would not have caused it to be treated as an institution with greater
than "normal" interest rate risk.
Quantitative Aspects of Market Risk. Security Federal does not maintain a
trading account for any class of financial instrument nor does it purchase high-
risk derivative instruments, although it has, in the past, engaged in limited
hedging activities to reduce its exposure to interest rate risk related to its
mortgage banking operation. Furthermore, Security Federal has no foreign
currency exchange rate risk or commodity price risk. For information regarding
the sensitivity to interest rate risk of Security Federal's interest-earning
assets and interest-bearing liabilities, see the tables under "Business of
Security Federal--Lending Activities--Maturity of Loan Portfolio," "--Securities
Activities" and "--Deposit Activities and Other Sources of Funds--Deposit
Accounts--Time Deposits by Rates and Maturities."
32
The Office of Thrift Supervision provides Security Federal with the
information presented in the following table. It presents the change in
Security Federal's net portfolio value at June 30, 1999, that would occur upon
an immediate change in interest rates based on Office of Thrift Supervision
assumptions, but without effect to any steps that management might take to
counteract that change.
NPV as %
Change in Portfolio Value of Assets
Interest Rates Net Portfolio Value --------------------------------
In Basis Points --------------------------------------------------- NPV Basis Point
(Rate Shock) Amount $ Change % Change Ratio Change
- --------------- ------ -------- -------- ---- ------
(Dollars in thousands)
300 $22,382 $(1,825) (7.5)% 11.59% (70)
200 23,569 (638) (2.6) 12.09 (20)
100 24,254 47 0.2 12.36 7
Static 24,207 -- -- 12.29 --
(100) 23,492 (715) (3.0) 11.93 (36)
(200) 23,342 (865) (3.6) 11.82 (47)
(300) 23,835 (372) (1.6) 11.99 (30)
The Office of Thrift Supervision uses certain assumptions in assessing
interest rate risk of savings associations. These assumptions relate to interest
rates, loan prepayment rates, deposit decay rates, and the market values of
certain assets under differing interest rate scenarios, among others.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react in different degrees to changes in market
interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Additionally, certain assets, such as adjustable rate mortgage loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. Further, if interest rates change, expected rates of
prepayments on loans and early withdrawals from certificates could deviate
significantly from those assumed in calculating the table.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-
earning assets and expense on interest-bearing liabilities. Net interest income
depends on the relative amounts of interest earning assets and interest-bearing
liabilities and the interest rate earned or paid on them.
33
Average Balances, Interest and Average Yields/Cost
The following table presents certain information for the periods indicated
regarding average balances of assets and liabilities as well as the total dollar
amounts of interest income from average interest-earning assets and interest
expense on average interest-bearing liabilities and average yields and costs.
The yields and costs for the periods indicated are derived by dividing income or
expense by the average balances of assets or liabilities, respectively, for the
periods presented. Nonaccruing loans have been included in the average loan
amounts. Average balances were derived from month-end balances. Management does
not believe that the use of month-end balances instead of daily balances causes
any material differences in the information presented.
At Year Ended June 30,
June 30, -----------------------------------------------------------------------------
1999 1999 1998
----------- ----------------------------------------- ---------------------------------
Average Average
Yield/ Average Yield/ Average Yield/
Rate Balance Interest Rate Balance Interest Rate
----------- ------------ ------------ -------- ----------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)................ 8.13% $196,997 $15,806 8.02% $273,674 $21,788 7.96%
Mortgage-backed securities.......... 6.44 5,928 378 6.38 5,576 380 6.81
Investment securities............... 5.18 19,864 1,189 5.99 18,238 1,158 6.35
Other interest-earning assets....... 7.49 6,639 406 6.12 11,107 659 5.93
-------- ------- -------- -------
Total interest-earning
assets...................... 7.85 229,428 17,779 7.75 308,595 23,985 7.77
Non-interest-earning assets......... 21,790 25,407
-------- --------
Total assets.................. $251,218 $334,002
======== ========
Interest-bearing liabilities:
Deposits:
NOW accounts..................... 0.76 $ 16,353 111 0.68 $ 13,368 92 0.69
Money market accounts............ 2.47 6,232 165 2.65 6,699 200 2.99
Savings accounts................. 2.36 46,412 1,146 2.47 46,089 1,303 2.83
Certificates of deposit.......... 4.95 124,857 6,428 5.15 158,891 9,232 5.81
-------- ------- -------- -------
Total deposits................ 3.77 193,854 7,850 4.05 225,047 10,827 4.81
FHLB advances....................... 5.54 25,749 1,574 6.11 74,904 4,639 6.19
-------- ------- -------- -------
Total interest-bearing
liabilities.................. 3.82 219,603 9,424 4.29 299,951 15,466 5.16
-------- --------
Noninterest-bearing liabilities..... 12,065 13,587
-------- --------
Total liabilities................ 231,668 313,538
Equity.............................. 19,550 20,464
-------- --------
Total liabilities and equity.. $251,218 $334,002
======== ========
Net interest income/interest rate
spread........................... $ 8,355 3.46% $ 8,519 2.61%
======= =======
Net interest margin/interest
earning assets................... 3.64% 2.76%
Ratio of interest-earning assets
to interest-bearing liabilities.. 104.47% 102.88%
======== ========
______________________________________
(1) Includes loans available for sale.
34
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on
the interest income and interest expense of Security Federal. The rate column
shows the effects attributable to changes in rate (changes in rate multiplied by
prior volume). The volume column shows the effects attributable to changes in
volume (changes in volume multiplied by prior rate). For purposes of this table,
changes attributable to changes in both rate and volume, which cannot be
segregated, have been allocated proportionately based on the absolute value of
the change due to rate and the change due to volume.
Year Ended
June 30, 1999
Compared to
Year Ended
June 30, 1998
-----------------------------------
Increase (Decrease)
Due to
---------------------
Rate Volume Total
-------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
Loans receivable........................................................... $ 169 $ (6,151) $ (5,982)
Mortgage-backed securities................................................. (25) 23 (2)
Investment securities...................................................... (69) 100 31
Other interest-earning assets.............................................. 20 (273) (253)
-------- --------- ---------
Total interest-earning assets........................................... 95 (6,301) (6,206)
-------- --------- ---------
Interest-bearing liabilities:
Deposits:
NOW accounts............................................................ (1) 20 19
Money market accounts................................................... (22) (13) (35)
Savings accounts........................................................ (166) 9 (157)
Certificates of deposit................................................. (974) (1,830) (2,804)
FHLB advances.............................................................. (59) (3,006) (3,065)
-------- --------- ---------
Total interest-bearing liabilities...................................... (1,222) (4,820) (6,042)
-------- --------- ---------
Increase (decrease) in net interest income.................................... $ (1,317) $ (1,481) $ (164)
======== ========= =========
Comparison of Financial Condition at June 30, 1999 and June 30, 1998
Total assets at June 30, 1999 were $191.5 million compared to $288.1
million at June 30, 1998, a decrease of $96.6 million, or 33.5%. The decrease
was primarily a result of loan repayments due to a decrease in market interest
rates, and sales of loans held for sale, which decreased Security Federal's need
for funds and enabled management to reduce high-cost deposits by $48.9 million
and reduce borrowed funds by $26.8 million. The sale of loans held for sale was
done as part of management's recent strategy to cease its former growth
strategy, which had included accelerating Security Federal's mortgage banking
operations, which included loan sale and servicing activities, and to decrease
expenses associated with its former growth strategy. See "Management's
Discussion and Analysis of Financial Information and Results of
Operations-Management's Strategy."
Total equity at June 30, 1999 was $18.5 million compared to $19.2 at June
30, 1998, a decrease of $688,000, or 3.6%, as a result of Security Federal's
1999 net loss of $608,000 as well as a $80,000 decrease in the unrealized gain
on securities available for sale.
Comparison of Operating Results for the Years Ended June 30, 1999 and June 30,
1998
General. Net loss for the year ended June 30, 1999 was $608,000 compared to
a net loss of $834,000 for the year ended June 30, 1998, a difference of
$226,000, or 27.1%. The difference was primarily a result of a $3.3 million
decrease in noninterest expense, primarily compensation and benefits associated
with the substantial number of
35
personnel Security Federal employed to handle its loan servicing operations,
which substantially ceased in 1999, substantially offset by a $2.7 million
decrease in noninterest income.
Interest Income. Interest income for the year ended June 30, 1999 was $17.8
million compared to $24.0 million for the year ended June 30, 1998, a decrease
of $6.2 million, or 25.8%. The decrease was primarily the result of a decrease
in the average balance of interest earning assets to $229.4 million for the year
ended June 30, 1999 from $308.6 million for the year ended June 30, 1998 due
primarily to Security Federal's loan sales as part of its 1998 change in
strategy. The average yield on interest-earning assets decreased slightly to
7.75% for the year ended June 30, 1999 from 7.77% for the year ended June 30,
1998.
Interest Expense. Interest expense for the year ended June 30, 1999 was
$9.4 million compared to $15.5 million for the year ended June 30, 1998, a
decrease of $6.1 million, or 39.4%. The decrease was primarily the result of a
decrease in the average balance of interest-bearing liabilities to $219.6
million for the year ended June 30, 1999 from $300.0 million for the year ended
June 30, 1998, primarily due to management's ability to repay substantial
borrowings it had outstanding to fund Security Federal's former growth strategy
following its loan sales. Additionally, the average cost of funds decreased to
4.29% for the year ended June 30, 1999 from 5.16% for the year ended June 30,
1998, primarily from Security Federal's repayment of borrowed funds which
carried interest rates in excess of 6.10%. The average cost of certificates of
deposit in particular decreased to 5.15% for the fiscal year ended June 30, 1999
from 5.81% for the fiscal year ended June 30, 1998 as a result of management's
efforts to reduce levels of higher cost deposit accounts.
Net Interest Income. Net interest income of $8.4 million for the year ended
June 30, 1999 reflects a decrease of $164,000 or 1.9% from the same period in
1998. The decrease in net interest income was primarily the result of the
decline in Security Federal's interest-earning assets, which was offset by an
increase in the net interest spread to 3.46% for the year ended June 30, 1999
from 2.61% for the year ended June 30, 1998, as well as an increase in the net
interest margin to 3.64% from 2.76% for the same period. The increase in net
interest spread and net interest margin were due primarily to Security Federal's
repayment of high cost borrowings in furtherance of management's change in
strategy.
Provision for Loan Losses. Security Federal's provision for loan losses for
the year ended June 30, 1999 increased $200,000 to $750,000 from $550,000 for
the year ended June 30, 1998 primarily due to increased loan charge-off activity
during 1999. Management increases the allowance for loan losses through a
provision charged to expense based on a statistical percentage developed
considering past loss experiences, delinquency trends and other factors, such as
portfolio composition. Security Federal's loan portfolio has changed as
management has increased the percentage of loans secured by commercial and
multi-family properties, which carry more credit risk. These loan types
represent almost 11.0% of the portfolio at June 30, 1999 compared to 5.6% in
1998 and 1.5% in 1997. Additionally, Security Federal's loss experience has
increased with net charge-offs of $570,000 in 1999 compared to $412,000 in 1998.
Noninterest Income. Noninterest income for the year ended June 30, 1999 was
$2.1 million compared to $4.8 million for the year ended June 30, 1998, a
decrease of $2.7 million, or 56.3%. The decrease was primarily the result of a
decline of $315,000 in loan servicing fees, net of amortization of mortgage
servicing rights, as well as a decline of $2.3 million in gains from sales of
mortgage loans to $1.5 million for the year ended June 30, 1999 from $3.8
million for the year ended June 30, 1998. Non-interest income for June 30, 1998
includes a one-time gain on sale of portfolio loans transferred to loans held
for sale of $1.6 million.
Noninterest Expense. Noninterest expense for the year ended June 30, 1999
was $10.3 million compared to $13.6 for the year ended June 30, 1998, a decrease
of $3.3 million, or 24.3%. Several factors contributed to the decrease,
including a $2.3 million decrease in compensation and employee benefits
attributable to a decreased number of employees from 178 at June 30, 1998 to 112
at June 30, 1999 as part of management's plan to reduce operating costs and a
$1.0 million decrease in other expenses, attributable to Security Federal's sale
of loan servicing rights related to loans serviced for others.
36
Income Taxes. There was no provision for income taxes for the year ended
June 30, 1999 or for the year ended June 30, 1998 due to Security Federal's
operating losses for both years. Net operating loss carryovers expire in fiscal
2013, however, management expects the net operating losses will be exhausted by
the end of fiscal 2001 and thereafter Security Federal will be taxed at the
normal federal and state tax rates.
Liquidity and Capital Resources
Security Federal's primary sources of funds are deposits and proceeds from
principal and interest payments on loans and mortgage-backed securities. While
maturities and scheduled amortization of loans and securities are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions and competition. Security Federal
generally manages the pricing of its deposits to be competitive and to increase
core deposit relationships.
Federal regulations require Security Federal to maintain minimum levels of
liquid assets. The required percentage has varied from time to time based upon
economic conditions and savings flows and is currently 4.0% of net withdrawable
savings deposits and borrowings payable on demand or in one year or less during
the preceding calendar month. Liquid assets for purposes of this ratio include
cash, certain time deposits, U.S. Government, government agency and corporate
securities and other obligations generally having remaining maturities of less
than five years. Security Federal has historically maintained its liquidity
ratio for regulatory purposes at levels in excess of those required. At June 30,
1999, Security Federal's liquidity ratio for regulatory purposes was 15.3%.
Security Federal's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities and
financing activities. Cash flows provided by operating activities were $54.4
million and $(45.9) million for the fiscal years ended June 30, 1999 and June
30, 1998, respectively. Net cash from investing activities consisted primarily
of disbursements for loan originations and the purchase of securities, offset by
principal collections on loans, proceeds from maturation and sales of
securities. Net cash from financing activities consisted primarily of activity
in deposit accounts and Federal Home Loan Bank advances.
Security Federal's most liquid assets are cash and short-term investments.
The levels of these assets are dependent on Security Federal's operating,
financing, lending and investing activities during any given period. At June 30,
1999, cash and short-term investments totaled $4.5 million. Security Federal has
other sources of liquidity if a need for additional funds arises, including
securities maturing within one year and the repayment of loans. Security Federal
may also utilize the sale of securities available-for-sale, federal funds
purchased, and Federal Home Loan Bank advances as a source of funds. At June 30,
1999, Security Federal had the ability to borrow a total of approximately $71.0
million from the Federal Home Loan Bank of Indianapolis. On that date, Security
Federal had outstanding advances of $5.0 million.
At June 30, 1999, Security Federal had outstanding commitments to originate
loans of $6.5 million, $5.9 million of which had fixed interest rates. These
loans are to be secured by properties located in its market area. Security
Federal anticipates that it will have sufficient funds available to meet its
current loan commitments. Loan commitments have, in recent periods, been funded
through liquidity or through FHLB borrowings. Certificates of deposit which are
scheduled to mature in one year or less from June 30, 1999 totaled $80.0
million. Management believes, based on past experience, that a significant
portion of such deposits will remain with Security Federal. Based on the
foregoing, in addition to Security Federal's high level of core deposits and
capital, Security Federal considers its liquidity and capital resources
sufficient to meet its outstanding short-term and long-term needs.
Liquidity management is both a daily and long-term responsibility of
management. Security Federal adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquid assets are invested generally in interest-earning overnight
deposits and short- and intermediate-term U.S. Government and agency obligations
and mortgage-backed securities of short duration. If Security Federal requires
funds beyond its ability to generate them internally, it has additional
borrowing
37
capacity with the Federal Home Loan Bank of Indianapolis. It is anticipated that
immediately upon completion of the Conversion, the Holding Company's and
Security Federal's liquid assets will be increased. See "Use of Proceeds."
Security Federal is subject to various regulatory capital requirements
imposed by the Office of Thrift Supervision. At June 30, 1999, Security Federal
was in compliance with all applicable capital requirements. See
"Regulation - Regulatory Capital Requirements" and "Pro Forma Regulatory Capital
Analysis" and Note 12 of the Notes to Consolidated Financial Statements.
Year 2000 Issues
General. The Year 2000 ("Y2K") issue confronting Security Federal and its
suppliers, customers, customers' suppliers, and competitors centers on the
inability of computer systems to recognize the year 2000. Many existing computer
programs and systems originally were programmed with six-digit dates that
provided only two digits to identify the calendar year in the date field. With
the impending new millennium, these programs and computers will recognize "00"
as the year 1900 rather than the year 2000.
Financial institution regulators recently have increased their focus upon
Y2K compliance issues and have issued guidance concerning the responsibilities
of senior management and directors. The Federal Financial Institutions
Examination Council has issued several interagency statements on Y2K project
management awareness. These statements require financial institutions to, among
other things, examine the Y2K implications of their reliance on vendors and with
respect to the data exchange and the potential impact of the Y2K issue on their
customers, suppliers, and borrowers. These statements also require each
federally regulated institution to survey its exposure, measure its risk, and
prepare a plan to address the Y2K issue. In addition, the federal banking
regulators have issued safety and soundness guidelines to be followed by insured
depository institutions, such as Security Federal, to assure resolution of any
Y2K problems. The federal banking agencies have assessed that Y2K testing and
certification is a key safety and soundness issue in conjunction with regulatory
exams and, thus, that an institution's failure to address appropriately the Y2K
issue could result in supervisory action, including reduction of the
institution's supervisory ratings, the denial of applications for approval of
mergers or acquisitions, or the imposition of civil money penalties.
Risks. Like most financial service providers, Security Federal and its
operations may be significantly affected by the Y2K issue due to its dependence
on technology and date-sensitive data. Computer software and hardware and other
equipment, both within and outside Security Federal's direct control, and third
parties with whom Security Federal electronically or operationally interfaces
(including without limitation its customers and third party vendors) are likely
to be affected. If computer systems are not modified in order to be able to
identify the year 2000, many computer applications could fail or create
erroneous results. As a result, many calculations which rely on date field
information, such as interest, payment on due dates, and all operating
functions, could generate results which are significantly misstated and Security
Federal could experience an inability to process transactions, prepare
statements, or engage in similar normal business activities. Likewise, under
certain circumstances, a failure to adequately address the Y2K issue could
adversely affect the viability of Security Federal's suppliers and creditors and
the creditworthiness of its borrowers. Thus, if not adequately addressed, the
Y2K issue could result in a significant adverse impact on Security Federal's
operations and, in turn, its financial condition and results of operations.
State of Readiness. Security Federal has established a formal plan to
address the Y2K issue consisting of the following phases:
Awareness Phase. Security Federal formally established a Y2K plan and
established a project team for management of the Y2K project. The
project team created a plan of action that includes milestones, budget
estimates, strategies, and methodologies to track and report the
status of the project. Members of the project team also attended
conferences and information sharing sessions to gain more insight into
the Y2K issue and potential strategies for addressing it. This phase
is complete.
38
Renovation Phase. Security Federal's corporate inventory revealed
that Y2K upgrades were available for all vendor-supplied
mission-critical systems, and all these Y2K-ready versions have been
delivered and placed into production and have entered the validation
process.
Validation Phase. The validation phase is designed to test the
ability of hardware and software to accurately process date-sensitive
data. Security Federal has completed the validation testing of each
mission-critical system. The project team completed various tests,
and during the validation testing process, no significant Y2K problems
have been identified relating to any modified or upgraded
mission-critical systems. In addition, all third party service
providers have confirmed to Security Federal that their systems have
been upgraded and are Y2K compliant.
Bank Resources Invested. Security Federal's Y2K project team was
assigned the tasks of ensuring that all systems across Security
Federal are identified, analyzed for Y2K compliance, corrected when
necessary, and tested and ensuring that all changes are implemented.
The Y2K project team members represent all functional areas of
Security Federal, including data processing, loan administration,
accounting, item processing and operations, compliance, human
resources, and marketing. Security Federal's Board of Directors
oversees the Y2K plan and provides guidance and resources to, and
receives quarterly updates from, the Y2K team.
Security Federal expensed all costs associated with required system
changes as those costs were incurred, and such costs were funded
through operating cash flows. The total cost of the Y2K conversion
project since commencement for Security Federal was $60,000 and all
various hardware and software upgrades have been made.
Contingency Plans. During the assessment phase, Security Federal began
developing back-up or contingency plans for each of its
mission-critical systems. Virtually all of Security Federal's
mission-critical systems are dependent upon third party vendors or
service providers. Therefore, contingency plans include selecting a
new vendor or service provider and converting their system. In the
event a current vendor's system fails during the validation phase and
it is determined that the vendor is unable or unwilling to correct the
failure, Security Federal will convert to a new system from a
pre-selected list of prospective vendors. In each case, realistic
trigger dates have been established to allow for orderly and
successful conversions. For some systems, contingency plans consist of
using spreadsheet software or reverting to manual systems until system
problems can be corrected.
Impact of Accounting Pronouncements and Regulatory Policies
Accounting for Derivative Instruments and Hedging Activities. Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," issued in June 1998 (as amended by SFAS No. 137),
standardizes the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts. The Statement requires
entities to carry all derivative instruments in the statement of financial
position at fair value. The accounting for changes in the fair value, gains and
losses, of a derivative instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and, if so, on the reasons for
holding it. If certain conditions are met, entities may elect to designate a
derivative instrument as a hedge of exposures to changes in fair value, cash
flows or foreign currencies. The statement is effective for financial statements
issued for periods beginning after June 15, 2000. Currently, Security Federal is
evaluating the effects of the statement.
Accounting for Mortgage-Backed Securities Retained After the Securitization
of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. Statement of
Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise," issued in October 1998, amends Statement of
Financial Accounting Standards No. 65, "Accounting for Certain Mortgage Banking
Activities," and Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," for years
beginning after December 15, 1998. SFAS No. 134 allows
39
entities with mortgage banking operations which convert pools of mortgages into
securities to classify these securities as available-for-sale, trading, or held-
to-maturity, instead of the current requirement to classify these pools as
trading. Security Federal adopted this standard on July 1, 1998, however, the
impact was not material to the consolidated financial statements.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared following generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time due to inflation. The primary impact of
inflation is reflected in the increased cost of Security Federal's operations.
Unlike most industrial companies, virtually all the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates
generally have a more significant impact on a financial institution's
performance than do general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services.
BUSINESS OF SECURITY FINANCIAL
General
Security Financial was organized as a Delaware business corporation at the
direction of Security Federal in September 1999 to become the Holding Company
for Security Federal upon completion of the conversion. As a result of the
conversion, Security Federal will be a wholly owned subsidiary of Security
Financial and all of the issued and outstanding capital stock of Security
Federal will be owned by Security Financial.
Business
Before the completion of the conversion, Security Financial will not engage
in any significant activities other than of an organizational nature. Upon
completion of the conversion, Security Financial's sole business activity will
be the ownership of the outstanding capital stock of Security Federal. In the
future, Security Financial may acquire or organize other operating subsidiaries,
although there are no current plans, arrangements, agreements or understandings,
written or oral, to do so.
Initially, Security Financial will neither own nor lease any property but
will instead use the premises, equipment and furniture of Security Federal with
the payment of appropriate rental fees, as required by applicable law and
regulations.
Since Security Financial will only hold the outstanding capital stock of
Security Federal after the conversion, the competitive conditions applicable to
Security Financial will be the same as those confronting Security Federal. See
"Business of Security Federal--Competition."
BUSINESS OF SECURITY FEDERAL
General
Security Federal was founded in 1935. Security Federal is regulated by the
Office of Thrift Supervision and the Federal Deposit Insurance Corporation.
Security Federal's deposits are insured to the maximum allowable amount by the
Savings Association Insurance Fund of the Federal Deposit Insurance Corporation.
Security Federal is a member of the Federal Home Loan Bank System.
40
Security Federal currently operates as a traditional savings bank,
specializing in single-family residential mortgage lending and savings deposits.
Security Federal's business consists primarily of attracting retail deposits
from the general public in the areas surrounding its seven full-service banking
offices and using those funds, together with funds generated from operations and
borrowings, to originate primarily one- to four-family residential mortgage
loans and, to a lesser extent, consumer loans, including home equity and second
mortgage loans, and multi-family and commercial real estate loans, construction
loans and commercial business loans. In the future, Security Federal intends to
increase its emphasis on consumer and multi-family and commercial real estate
and commercial business loans. Security Federal currently originates loans for
investment and loans for sale in the secondary market, releasing the servicing
rights to all loans sold. Security Federal also invests in mortgage-backed
securities, securities issued by the U.S. Government and other investments
permitted by applicable laws and regulations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Management Strategy."
Security Federal generally holds its loans for long-term investment purposes.
See "--Lending Activities." Because a large portion of Security Federal's
assets consist of fixed-rate mortgage loans, Security Federal's earnings could
be hurt by rising interest rates. See "Risk Factors--Rising Interest Rates
Could Hurt Security Federal's Profits."
Market Area
Security Federal is headquartered in St. John, Indiana in Lake County.
Security Federal's primary deposit gathering and lending area is concentrated in
the communities surrounding its six banking offices located in Lake County and
one banking office located in Porter County, as well as Cook and Will counties
in Illinois. Lake and Porter Counties are located in the northwest corner of
Indiana, immediately southeast of Chicago, Illinois. It is only approximately 30
miles from the heart of Lake County to the heart of neighboring Chicago. Several
major highways, nearly 100 truck lines, and 11 railways serve the area,
providing versatility and convenience of transportation. Expanding airport
facilities provide service for corporate and business needs. While primarily a
home to several steel manufacturers, Lake County has a diversified mix of
industry groups, including insurance and financial services, manufacturing,
service, government and retail. The major employers in the area include U.S.
Steel, NIPSCO Industries, Inc., Whiteco Industries, Porter Memorial Hospital,
Valparaiso University, Valparaiso Community Schools, McGill Manufacturing and
Hunt Wesson. According to published statistics, Lake County's 1998 population
was approximately 478,323, an increase of 0.6% from 1990, ranking it the second
most populous county in Indiana. In addition, the 1998 median household incomes
of Lake and Porter counties was approximately $38,310 and $47,920, respectively,
compared to approximately $39,194 and $38,135 in Indiana and the United States,
respectively.
Competition
Security Federal faces intense competition for the attraction of deposits
and origination of loans in its primary market area. Its most direct competition
for deposits has historically come from the several commercial banks operating
in Security Federal's primary market area and, to a lesser extent, from other
financial institutions, such as brokerage firms, credit unions and insurance
companies. Particularly in times of high interest rates, Security Federal has
faced additional significant competition for investors' funds from short-term
money market securities and other corporate and government securities. Security
Federal's competition for loans comes primarily from the commercial banks and
loan brokers operating in its primary market area. Competition for deposits and
the origination of loans may limit Security Federal's growth in the future.
Lending Activities
General. At June 30, 1999, Security Federal's net loans totaled $148.3
million, or 77.4% of total assets. Security Federal has concentrated its lending
activities on one- to four-family mortgage loans and consumer and other loans,
with these loans amounting to 57.4% and 23.4%, respectively, of loans at June
30, 1999. To a lesser extent, Security Federal also originates multi-family and
commercial real estate, construction and commercial business loans.
41
Loan Portfolio Analysis. The following table presents the
composition of Security Federal's loan portfolio at the dates indicated.
Security Federal had no concentration of loans exceeding 10% of total loans
receivable other than as disclosed below.
At June 30,
-------------------------------------------------------------
1999 1998
--------------------------- --------------------------
Percent Percent
Amount of Total Amount of Total
--------- --------- ------- ----------
(Dollars in thousands)
Real estate loans:
One- to four-family (1)...................................... $ 86,086 57.44% $102,556 56.24%
Multi-family and commercial real estate...................... 16,420 10.96 10,133 5.56
Construction................................................. 6,414 4.28 13,027 7.14
-------- ------ -------- ------
Total real estate loans................................... 108,920 72.68 125,716 68.94
Consumer and other loans:
Automobile................................................... 15,980 10.66 25,059 13.74
Home equity and second mortgage.............................. 17,478 11.66 20,751 11.38
Other........................................................ 1,616 1.08 2,361 1.29
-------- ------ -------- ------
Total consumer and other loans............................ 35,074 23.40 48,171 26.41
Commercial business loans....................................... 5,867 3.92 8,480 4.65
-------- ------ -------- ------
Total loans............................................... 149,861 100.00% 182,367 100.00%
====== ======
Less:
Loans in process............................................. -- 119
Net deferred loan origination fees........................... 76 114
Allowance for loan losses.................................... 1,469 1,289
-------- --------
Net loans................................................. $148,316 $180,845
======== ========
- --------------------------------------
(1) Excludes loans available for sale.
One- to Four-Family Real Estate Loans. Currently, Security Federal
originates loans secured by one- to four-family residences primarily located in
its primary market area. At June 30, 1999, $86.1 million, or 57.4%, of Security
Federal's total loan portfolio consisted of one- to four-family loans. At June
30, 1999, 53.3% of Security Federal's one- to four-family real estate loans were
adjustable rate loans and 46.7% were fixed-rate loans. In the past, Security
Federal purchased ARM loans originated through correspondent relationships and
secured by properties located outside of its primary market area, many of which
Security Federal continues to hold in its portfolio.
Security Federal offers a variety of fixed and adjustable-rate
mortgage loan products. The loan fees charged, interest rates and other
provisions of Security Federal's mortgage loans are determined by Security
Federal on the basis of its own pricing criteria and market conditions.
Generally, all loans originated by Security Federal conform to Fannie Mae and
Freddie Mac underwriting standards. Security Federal's fixed-rate loans
typically have maturities of 10 to 30 years, although 30-year loans constitute
the largest percentage of originations. Security Federal also offers five- and
seven-year balloon mortgages based on a 30-year amortization schedule. Security
Federal's ARM loans are typically based on a 15-year or 30-year amortization
schedule. Interest rates and payments on Security Federal's ARM loans generally
are adjusted annually after a specified period ranging from one to three years
to a rate typically equal to 2.75% above the one-year constant maturity Treasury
index. Security Federal currently offers ARM loans with initial rates below
those which would prevail under the foregoing computation, determined by
Security Federal based on market
42
factors and competitive rates for loans having similar features offered by other
lenders for such initial periods. The maximum amount by which the interest rate
may be increased or decreased in a given period on Security Federal's ARM loans
is generally 2% per adjustment period and the lifetime interest rate cap is
generally 6% over the initial interest rate of the loan. Security Federal
qualifies the borrower based on the borrower's ability to repay the ARM loan
based on the maximum interest rate at the first adjustment, in the case of one-
year ARM loans, and based on the initial interest rate in the case of ARM loans
that adjust after three or more years. Security Federal does not originate
negative amortization loans. The terms and conditions of the ARM loans offered
by Security Federal, including the index for interest rates, may vary from time
to time. Security Federal believes that the annual adjustment feature of its ARM
loans also provides flexibility to meet competitive conditions as to initial
rate concessions while preserving Security Federal's return on equity objectives
by limiting the duration of the initial rate concession.
Borrower demand for ARM loans versus fixed-rate mortgage loans is
a function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate
mortgage loans and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment. As a result of
the low interest rate environment in recent years, Security Federal has
experienced a strong customer preference for fixed-rate loans.
The retention of ARM loans in Security Federal's loan portfolio
helps reduce Security Federal's exposure to changes in the interest rates. There
are, however, unquantifiable credit risks resulting from the potential of
increased costs due to changed rates to be paid by the customer. It is possible
that, during periods of rising interest rates, the risk of default on ARM loans
may increase as a result of repricing and the increased costs to the borrower.
Furthermore, because the ARM loans originated by Security Federal generally
provide, as a marketing incentive, for initial rates of interest below the rates
which would apply were the adjustment index used for pricing initially
(discounting), these loans are subject to increased risks of default or
delinquency. Another consideration is that although ARM loans allow Security
Federal to increase the sensitivity of its asset base to changes in interest
rates, the extent of this interest sensitivity is limited by the periodic and
lifetime interest rate adjustment limits. Because of these considerations,
Security Federal has no assurance that yields on ARM loans will be sufficient to
offset increases in Security Federal's cost of funds.
While fixed-rate one- to four-family residential real estate loans
are normally originated with 10- to 30-year terms, and Security Federal permits
its ARM loans to be assumed by qualified borrowers, such loans typically remain
outstanding for substantially shorter periods. This is because borrowers often
prepay their loans in full upon sale of the property pledged as security or upon
refinancing the original loan. In addition, substantially all mortgage loans in
Security Federal's loan portfolio contain due-on-sale clauses providing that
Security Federal may declare the unpaid amount due and payable upon the sale of
the property securing the loan. Security Federal enforces these due-on-sale
clauses to the extent permitted by law and as business judgment dictates. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates
and the interest rates payable on outstanding loans.
Security Federal requires title insurance insuring the status of its
first lien on real estate secured loans and also requires that the fire and
extended coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least equal to the outstanding loan balance.
Security Federal's residential mortgage loans typically do not
exceed 80% of the appraised value of the property. Security Federal's lending
policies permit Security Federal to lend up to 95% of the appraised value of the
property; however, Security Federal generally requires private mortgage
insurance on the portion of the principal amount that exceeds 80% of the
appraised value of the property. Security Federal obtains appraisals on all
first mortgage real estate loans from outside appraisers.
Multi-family and Commercial Real Estate Loans. Security Federal
originates and purchases mortgage loans for the acquisition and refinancing of
multi-family and commercial real estate properties. Security Federal began
offering commercial loans in 1996. At June 30, 1999, $16.4 million, or 11.0% of
Security Federal's total loans, consisted of loans secured by multi-family
residential property and commercial real estate.
43
Multi-family and commercial real estate loans are fully amortizing
loans that are generally originated with fixed interest rates with rates tied to
the U.S. Treasury index, but are occasionally originated with variable rates
with rates tied to the prime lending rate. The maximum term for a fixed-rate
multifamily loan generally is generally 10 years. The maximum loan-to-value
ratio for a multifamily or commercial loan is 75%.
At June 30, 1999, the largest multi-family loan had a committed
balance of $2.7 million and was secured by a residential development located in
Crown Point, Indiana, and was performing according to its original terms.
At June 30, 1999, Security Federal's commercial real estate loans
were secured by office, retail and owner occupied properties, all of which are
located in Indiana and Illinois. At June 30, 1999, Security Federal's largest
commercial real estate loan had an outstanding balance of $1.7 million. The loan
is secured by a hotel located in Columbia City, Indiana. At June 30, 1999, this
loan was performing according to its original terms.
Multi-family and commercial real estate lending affords Security
Federal an opportunity to receive interest at rates higher than those generally
available from one- to four-family residential lending. However, loans secured
by these properties usually are greater in amount and are more difficult to
evaluate and monitor and, therefore, involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on loans secured by
income producing properties are often dependent on the successful operation and
management of the properties, repayment of these loans may be affected by
adverse conditions in the real estate market or the economy. Security Federal
seeks to minimize these risks by generally limiting the maximum loan-to-value
ratio to up to 75% for multi-family and commercial real estate loans and by
strictly scrutinizing the financial condition of the borrower, the cash flow of
the project, the quality of the collateral and the management of the property
securing the loan. Security Federal also generally obtains loan guarantees from
financially capable parties based on a review of personal financial statements.
See "Risk Factors--Security Federal's loan portfolio possesses increased risk
due to Security Federal's substantial number of consumer, multi-family and
commercial real estate, commercial business and residential construction loans
which may result in an increase in non-performing loans and even loan losses."
Residential Construction Loans. Security Federal originates
residential construction loans to local home builders and to individuals for the
construction and acquisition of personal residences. At June 30, 1999,
residential construction loans amounted to $6.4 million, or 4.3% of Security
Federal's total loans.
Security Federal's construction loans to builders generally have fixed
interest rates and are for a term of six months. Loans to builders are typically
made with a maximum loan to value ratio of 75%. These loans are usually made to
the builder before there is an identified buyer for the completed home. At June
30, 1999, the largest amount of construction loans outstanding to one builder
was $2.7 million. Construction loans to individuals are made on the same terms
as Security Federal's mortgage loans, but provide for the payment of interest
only during the construction phase, which is usually six months with a
contingency for an additional six months. At the end of the construction phase,
the loan converts to a permanent mortgage loan.
Before making a commitment to fund a construction loan, Security
Federal requires an appraisal of the property by an independent certified
appraiser. Security Federal also reviews and inspects each project before
disbursement of funds during the term of the construction loan. Loan proceeds
are disbursed after inspection based on the percentage of completion.
Construction lending affords Security Federal the opportunity to
earn higher interest rates with shorter terms to maturity relative to single-
family permanent mortgage lending. Construction lending, however, is generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost of the
project. These loans are generally more difficult to evaluate and monitor. If
the estimate of construction cost proves to be inaccurate, Security Federal may
be required to advance funds beyond the amount originally committed to protect
the value of the project. If the estimate of value upon completion proves to be
inaccurate, Security Federal may be confronted with a project whose value is
insufficient to assure full repayment. Projects may also be jeopardized by
disagreements between borrowers and builders and by the failure of builders to
pay subcontractors. Loans to builders to construct homes for
44
which no purchaser has been identified carry more risk because the payoff for
the loan depends on the builder's ability to sell the property before the
construction loan is due.
Security Federal has attempted to minimize the foregoing risks by,
among other things, limiting its construction lending to residential properties.
It is also Security Federal's general policy to obtain regular financial
statements from builders so that it can monitor their financial strength and
ability to repay.
Consumer and Other Loans. Another significant lending activity of
Security Federal is the origination of consumer and other loans. Security
Federal's consumer and other loans consist primarily of home equity and second
mortgage loans and automobile loans. At June 30, 1999, Security Federal's
consumer and other loans totaled approximately $35.1 million, or 23.4% of
Security Federal's total loans.
At June 30, 1999, Security Federal had $17.5 million, or 11.7% of
all loans, of home equity and second mortgage loans. Most of these loans are
made to existing customers. Security Federal originates home equity loans in the
form of lines of credit. Security Federal's home equity loans have variable
interest rates tied to the six-month U.S. Treasury index. In the future,
Security Federal intends to tie these variable interest rates loans to the prime
lending rate. Security Federal imposes a maximum loan-to-value ratio on its home
equity loans of 80% after considering both the first and second mortgage loans.
The maximum loan-to-value rate on Security Federal's second mortgage loans is
80%. Both Security Federal's home equity and second mortgage loans are limited
in term to 120 months. Security Federal's home equity loans and second mortgages
may have greater credit risk than one- to four-family residential mortgage loans
because they are secured by mortgages subordinated to an existing first mortgage
on the property, which, in most cases, is held by Security Federal.
Security Federal also originates consumer loans secured by
automobiles and, occasionally, boats and other recreational vehicles. At June
30, 1999, Security Federal had $16.0 million, or 10.7% of all loans, of
automobile loans. Automobile loans are secured by both new and used cars and
light trucks. Both new and used cars are financed for a period of up to 60
months and the rate on such loans is fixed for the term of the loan. In the
past, Security Federal also offered indirect automobile loans. The indirect
automobile loans were originated through automobile dealers in Indiana and
Illinois. These dealers provided Security Federal applications to finance
vehicles sold by their dealerships. At June 30, 1999, $12.2 million, or 76.2% of
all automobile loans were indirect automobile loans. Security Federal no longer
offers indirect automobile loans.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various Federal and state laws, including
Federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. Such loans may also give rise to claims and defenses
by a consumer loan borrower against an assignee of such loans such as Security
Federal, and a borrower may be able to assert against such assignee claims and
defenses that it has against the seller of the underlying collateral. See "Risk
Factors--Security Federal's loan portfolio possesses increased risk due to
Security Federal's substantial number of consumer, multi-family and commercial
real estate, commercial business and residential construction loans which may
result in an increase in non-performing loans and even loan losses."
Commercial Business Loans. At June 30, 1999, Security Federal had
$5.9 million in commercial business loans which amounted to 3.9% of total loans.
Security Federal makes commercial business loans primarily in its market area to
a variety of professionals, sole proprietorships and small businesses. Security
Federal offers a variety of commercial lending products, including term loans
for fixed assets and working capital, revolving lines of credit, letters of
credit, and Small Business Administration guaranteed loans. Secured commercial
business loans are generally made in amounts up to $500,000, although Security
Federal policy would permit it to lend up to its legal lending limit of $3.0
million. Unsecured lines of credit generally are made for up to $250,000. Term
loans are generally offered with fixed
45
rates of interest of up to 5 years. Business lines of credit have adjustable
rates of interest and are payable on demand, subject to annual review and
renewal. Business loans with variable rates of interest adjust on a daily basis
and are generally indexed to the prime rate as published in The Wall Street
Journal.
In making commercial business loans, Security Federal considers the
financial statements of the borrower, Security Federal's lending history with
the borrower, the debt service capabilities of the borrower, the projected cash
flows of the business and the value of the collateral. Commercial business loans
are generally secured by a variety of collateral, primarily equipment, assets
and accounts receivable, and are supported by personal guarantees. Depending on
the collateral used to secure the loans, commercial loans are made in amounts of
up to 75% of the adjusted value of the collateral securing the loan. Security
Federal generally does not make unsecured commercial loans. In an effort to
increase its emphasis on commercial loans, Security Federal intends to hire an
experienced commercial loan officer with the primary responsibility of
increasing commercial business and real estate loan volume.
Unlike mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment or other income,
and which are secured by real property whose value tends to be more easily
ascertainable, commercial loans are of higher risk and typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
borrower's business. As a result, the availability of funds for the repayment of
commercial loans may be substantially dependent on the success of the business
itself. Further, any collateral securing such loans may depreciate over time,
may be difficult to appraise and may fluctuate in value. See "Risk Factors--
Security Federal's loan portfolio possesses increased risk due to Security
Federal's substantial number of consumer, multi-family and commercial real
estate, commercial business and residential construction loans which may result
in an increase in non-performing loans and even loan losses." At June 30, 1999,
Security Federal's largest commercial loan was for $1.0 million to a car
dealership located in East Chicago, Indiana.
Loans to One Borrower. The maximum amount that Security Federal may
lend to one borrower is limited by federal regulations. At June 30, 1999,
Security Federal's regulatory limit on loans to one borrower was $3.0 million.
At that date, Security Federal's largest amount of loans to one borrower,
including the borrower's related interests, was $1.72 million and consisted of
one loan. This loan was performing according to its original terms at June 30,
1999.
Maturity of Loan Portfolio. The following table presents certain
information at June 30, 1999 regarding the dollar amount of loans maturing in
Security Federal's portfolio based on their contractual terms to maturity, but
does not include potential prepayments. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
becoming due within one year. Loan balances do not include undisbursed loan
proceeds, unearned discounts, unearned income and allowance for loan losses.
At June 30, 1999
-------------------------------------------------------------------------
Home
Multi-family Equity
One- and and
to Four- Commercial Second
Family(1) Real Estate Construction Automobile Mortgage
----------- ------------ ------------ ---------- ---------
(Dollars in thousands)
Amounts due in:
One year or less......................... $ 227 $ 1,416 $5,994 $ 394 $ 4,228
More than one year to
three years........................... 449 1,203 420 4,439 477
More than three years to
five years............................ 555 6,089 -- 11,079 1,422
More than five years to 10 years......... 1,555 7,666 -- 68 6,378
More than 10 years to 20 years........... 10,697 46 -- -- 4,973
More than 20 years....................... 72,603 -- -- -- --
------- ------- ------ ------- -------
Total amount due...................... $86,086 $16,420 $6,414 $15,980 $17,478
======= ======= ====== ======= =======
----------------------------------
Other Commercial Total
Consumer Business Loans
-------- ---------- -------
Amounts due in:
One year or less..................... $ 818 $2,701 $ 15,778
More than one year to
three years....................... 401 856 8,245
More than three years to
five years........................ 157 1,284 20,586
More than five years to 10 years..... 240 1,026 16,933
More than 10 years to 20 years....... -- -- 15,716
More than 20 years................... -- -- 72,603
-------- ------ --------
Total amount due.................. $1,616 $5,867 $149,861
======== ====== ========
--------------------------------------
(1) Excludes loans available for sale.
46
The following table presents the dollar amount of all loans due
after June 30, 2000, which have fixed interest rates and have floating or
adjustable interest rates.
Due After June 30, 2000
--------------------------------------------------
Fixed- Adjustable-
Rate Rate Total
------------ ------------ ----------
(Dollars in thousands)
Amounts due in:
Real estate loans:
One- to four-family (1)...................... $40,083 $45,776 $ 85,859
Multi-family and commercial real estate...... 4,513 10,491 15,004
Construction................................. 165 255 420
------- ------- --------
Total real estate loans...................... 44,761 56,522 101,283
------- ------- --------
Consumer and other loans:
Automobile........................................ 15,586 -- 15,586
Home equity and second mortgage................... 7,515 5,735 13,250
Other............................................. 730 68 798
------- ------- --------
Total consumer and other loans................. 23,831 5,803 29,634
------- ------- --------
Commercial business loans............................ 1,322 1,844 3,166
------- ------- --------
Total loans.................................... $69,914 $64,169 $134,083
======= ======= ========
- ---------------------------------------
(1) Excludes loans available for sale.
Scheduled contractual principal repayments of loans do not reflect
the actual life of the loans. The average life of a loan is substantially less
than its contractual term because of prepayments. In addition, due-on-sale
clauses on loans generally give Security Federal the right to declare loans
immediately due and payable if, among other things, the borrower sells the real
property with the mortgage and the loan is not repaid. The average life of a
mortgage loan tends to increase, however, when current mortgage loan market
rates are substantially higher than rates on existing mortgage loans and,
conversely, tends to decrease when rates on existing mortgage loans are
substantially higher than current mortgage loan market rates.
Loan Solicitation and Processing. Security Federal's lending
activities follow written, non-discriminatory, underwriting standards and loan
origination procedures established by Security Federal's Board of Directors and
management. Loan originations come from a number of sources. The customary
sources of loan originations are mortgage brokers, loan correspondents, loan
origination officers, realtors, referrals and existing customers. Various
executive officers have the authority to approve secured and unsecured loans as
permitted by the Board of Directors. Currently, Mr. Hyland has authority to
approve secured and unsecured loans with balances of up to and including
$500,000 and $250,000, respectively. Larger loans must be approved by either Mr.
Hyland and at least two other members of Security Federal's corporate loan
committee, four members of the corporate loan committee or the loan committee of
the Board. Any loans exceeding $2.0 million must be approved by the Board.
Loan Originations, Purchases and Sales. Security Federal's mortgage
lending activities are conducted primarily by its correspondent banks and
brokers and commissioned loan personnel operating at its full service banking
offices and loan offices. All loans originated by Security Federal are
underwritten by Security Federal pursuant to Security Federal's policies and
procedures. Security Federal originates both adjustable-rate and fixed-rate
mortgage loans. Security Federal's ability to originate fixed- or adjustable-
rate loans is dependent upon the relative customer demand for such loans, which
is affected by the current and expected future level of interest rates. Security
Federal recently has sought to expand its commercial lending to enhance the
yield on its loan portfolio and to encourage business relationships with the
borrowers, including through checking and other accounts and other loans.
Additionally, as part of its mortgage banking operation, Security Federal
purchases whole loans, and to a limited extent loan participations, all with
servicing released.
47
In an effort to manage its interest rate risk position, Security
Federal generally sells the fixed-rate mortgage loans with terms in excess of 15
years that it originates. However, Security Federal has retained and will retain
selected 30-year, fixed-rate loans in order to build its loan portfolio and
increase the yield on its interest-earning assets. The sale of loans in the
secondary mortgage market reduces Security Federal's risk that the interest
rates paid to depositors will increase while Security Federal holds long-term,
fixed-rate loans in its portfolio. It also allows Security Federal to continue
to fund loans when savings flows decline or funds are not otherwise available.
Security Federal currently generally sells loans, servicing released without
recourse to Fannie Mae. Gains, net of origination expense, from the sale of such
loans are recorded at the time of sale. Generally a loan is committed to be sold
and a price for the loan is fixed after the loan is approved and the interest
rate is accepted by the customer. This eliminates the risk to Security Federal
that a rise in market interest rates will reduce the value of a mortgage before
it can be sold.
In the past, Security Federal generally retained the servicing
rights on the mortgage loans it sold. Servicing loans for others generally
consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors and foreclosure processing. In October 1998,
however, Security Federal sold the servicing rights related to approximately
$920.0 million in loans serviced for others. At June 30, 1999, Security Federal
was servicing loans for others amounting to approximately $322 million. In
August 1999, Security Financial arranged for the sale of the remaining servicing
rights held by Security Federal, relating to approximately $320.0 million in
loans serviced for others. Currently, all loans sold by Security Federal are
sold servicing released.
48
The following table presents total loans (including loans held for sale)
originated, purchased, sold and repaid during the periods indicated.
For the Year Ended June 30,
-------------------------------
1999 1998
--------- ---------
(In thousands)
Total loans at beginning of period............................................ $ 230,332 $ 259,976
Originations:
Real estate:
One- to four-family.................................................. 60,910 57,443
Multi-family and commercial real estate.............................. 7,620 12,845
Construction......................................................... 3,256 7,741
--------- ---------
Total real estate................................................. 71,786 78,029
Consumer and other:
Automobile........................................................... 1,022 20,884
Home equity and second mortgage...................................... 2,977 6,707
Other................................................................ 1,249 2,987
--------- ---------
Total consumer and other.......................................... 5,248 30,578
Commercial business..................................................... 1,271 1,860
--------- ---------
Total loans originated............................................ 78,305 110,467
Purchases:
Real estate:
One- to four-family.................................................. 211,065 274,246
Multi-family and commercial real estate.............................. -- --
Construction......................................................... 15,164 27,919
--------- ---------
Total real estate................................................. 226,229 302,165
Consumer and other:
Automobile........................................................... -- --
Home equity and second mortgage...................................... -- --
Other................................................................ -- --
--------- ---------
Total consumer and other.......................................... -- --
Commercial business..................................................... -- --
--------- ---------
Total loans purchased............................................. 226,229 302,165
Sales and repayments:
Real estate:
One- to four-family.................................................. (334,502) (381,034)
Multi-family and commercial real estate.............................. (1,333) (7,548)
Construction......................................................... (25,033) (34,824)
--------- ---------
Total real estate................................................. (360,868) (423,406)
Consumer and other:
Automobile........................................................... (10,101) (9,736)
Home equity and second mortgage...................................... (6,250) (5,326)
Other................................................................ (1,994) (3,421)
--------- ---------
Total consumer and other.......................................... (18,345) (18,483)
Commercial business..................................................... (3,884) (435)
--------- ---------
Total sales and repayments........................................... (383,097) (442,324)
--------- ---------
Less:
Loans in process........................................................... (119) 176
Deferred loan fees......................................................... (38) 11
Allowance.................................................................. 180 (139)
--------- ---------
23 48
--------- ---------
Net loan activity............................................................. (78,586) (29,644)
--------- ---------
Total loans at end of period.................................................. $ 151,746 $ 230,332
========= =========
49
Loan Commitments. Security Federal issues commitments for loans conditioned
upon the occurrence of certain events. Commitments are made in writing on
specified terms and conditions and are honored for up to 90 days from approval.
At June 30, 1999, Security Federal had variable rate loan commitments totaling
$626,000, ranging in rates from 6.75% to 7.375%, and fixed-rate loan commitments
totaling $5.9 million, ranging in rates from 6.625% to 8.375%. See Note 13 of
the Notes to Consolidated Financial Statements included in the back of this
prospectus.
Loan Fees. In addition to interest earned on loans, Security Federal
receives income from fees in connection with loan originations, loan
modifications, late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.
Security Federal charges loan origination fees for fixed-rate loans which
are calculated as a percentage of the amount borrowed. As required by applicable
accounting principles, loan origination fees and discount points in excess of
loan origination costs are deferred and recognized over the contractual
remaining lives of the related loans on a level yield basis. Discounts and
premiums on loans purchased are accreted and amortized in the same manner. At
June 30, 1999, Security Federal had $76,000 of net deferred loan fees. Security
Federal recognized $38,000 and $50,000 of net deferred loan fees during the
years ended June 30, 1999 and 1998, respectively, in connection with loan
refinancings, payoffs, sales and ongoing amortization of outstanding loans.
Nonperforming Assets and Delinquencies. When a borrower fails to make a
required loan payment, Security Federal attempts to cure the deficiency by
contacting the borrower and seeking the payment. A late notice is mailed after
30 days of delinquency. In most cases, deficiencies are cured promptly. If a
delinquency continues beyond the 30th day of the delinquency, a phone call to
the borrower is usually made on the 45th day of delinquency. On or about the
60th day of delinquency, Security Federal sends a certified letter to the
borrower giving the borrower 10 days in which to work out a payment schedule.
While Security Federal generally prefers to work with borrowers to resolve
problems, Security Federal will institute foreclosure or other proceedings after
the 90th day of a delinquency, as necessary, to minimize any potential loss.
Management informs the Board of Directors monthly of the amount of loans
delinquent more than 60 days, all loans in foreclosure, and all foreclosed and
repossessed property that Security Federal owns.
Security Federal ceases accruing interest on mortgage loans when, in the
judgment of management, the probability of collection of interest is deemed to
be insufficient to warrant further accrual. Security Federal does not accrue
interest on mortgage loans past due 90 days or more when the estimated value of
collateral and collection efforts are deemed insufficient to ensure full
recovery. The amount of interest foregone on nonaccrual loans was not material
during fiscal 1999 or fiscal 1998.
50
The following table presents information with respect to Security Federal's
nonperforming assets at the dates indicated. Security Federal had no
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 15 on the dates indicated.
At June 30,
--------------------------
1999 1998
------ ------
(Dollars in thousands)
Nonaccruing loans:
Real estate:
One- to four-family............................................. $1,705 $2,154
Multi-family and commercial real estate......................... -- --
Construction.................................................... 42 277
------ ------
Total real estate............................................ 1,747 2,431
Consumer and other:
Automobile...................................................... 213 220
Home equity and second mortgage................................. 107 87
Other........................................................... 40 203
------ ------
Total consumer and other..................................... 360 510
Commercial business................................................ -- --
------ ------
Total nonaccruing loans (1)..................................... 2,107 2,941
Loans past due 90 days and accruing interest.......................... -- --
------ ------
Total nonperforming loans....................................... 2,107 2,941
Real estate owned..................................................... 295 481
------ ------
Total nonperforming assets (2).................................. $2,402 $3,422
====== ======
Loan allowance as a percentage of total loans......................... 0.98% 0.71%
Loan allowance as a percentage of non-performing loans................ 69.72% 43.83%
Total nonperforming loans as a percentage of total loans.............. 1.41% 1.61%
Total nonperforming assets as a percentage of total assets............ 1.25% 1.19%
____________________________
(1) Total nonaccruing loans equals total nonperforming loans.
(2) Nonperforming assets consist of nonperforming loans, impaired loans, real
estate owned and other repossessed assets.
51
The following table sets forth the delinquencies in Security Federal's loan
portfolio as of the dates indicated. Security Federal increased its collection
efforts in fiscal 1999, which contributed to a decrease in delinquencies
compared to fiscal 1998.
At June 30, 1999 At June 30, 1998
--------------------------------------- -------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------ ------------------ ----------------- -----------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of of Balance of of Balance of of Balance of
Loans Loans Loans Loans Loans Loans Loans Loans
------ ---------- ------ ---------- ------- ---------- ------- ----------
(Dollars in thousands)
Real estate:
One- to four-family...................... 10 $ 635 23 $ 1,705 19 $ 1,003 25 $ 2,154
Multi-family and commercial real estate.. -- -- -- -- -- -- -- --
Construction............................. -- -- 1 42 4 638 3 277
Consumer and other:
Automobile.............................. 8 91 18 213 17 208 18 220
Home equity and second mortgage......... 4 106 5 107 8 243 5 87
Other................................... 7 14 13 40 6 20 51 203
Commercial business........................ 2 523 -- -- -- -- -- --
---- --------- ------ ---------- ---- ------- ---- -------
Total............................. 31 $ 1,369 60 $ 2,107 54 $ 2,112 102 $ 2,941
==== ========= ====== ========== ==== ======= ==== =======
Delinquent loans to total loans............ 0.91% 1.41% 1.16% 1.61%
Real Estate Owned. Real estate acquired by Security Federal as a result of
foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned
until sold. When property is acquired it is recorded at fair market value at the
date of foreclosure, establishing a new cost basis. If the fair value declines,
Security Federal records a valuation allowance through expense. Costs after
acquisition are expensed. At June 30, 1999, Security Federal had $295,000 of
real estate owned, consisting of one residential property and one commercial
property.
Asset Classification. The Office of Thrift Supervision has adopted various
regulations regarding problem assets of savings institutions. The regulations
require that each insured institution review and classify its assets on a
regular basis. In addition, Office of Thrift Supervision examiners have
authority to identify problem assets during examinations and, if appropriate,
require them to be classified.
There are three classifications for problem assets: substandard, doubtful
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover possible losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention." Security Federal monitors "special mention"
assets.
52
The aggregate amounts of Security Federal's classified and special mention
assets at the dates indicated were as follows:
At June 30,
------------------------------
1999 1998
----------- -----------
(In thousands )
Classified assets:
Loss ......................................................... $ 210 $ 94
Doubtful ..................................................... -- --
Substandard .................................................. 2,899 4,020
Special mention .............................................. 669 679
At June 30, 1999, assets designated substandard consisted of real estate
owned of $295,000 and residential mortgage loans totaling $2.0 million, and
assets designated as special mention consisted of $551,000 in residential
mortgage loans. Classified assets decreased substantially from fiscal 1998 to
fiscal 1999 due primarily to Security Federal's efforts to improve collection
efforts during fiscal 1999.
Allowance for Loan Losses. In originating loans, Security Federal
recognizes that losses will be experienced and that the risk of loss will vary
with, among other things, the type of loan being made, the creditworthiness of
the borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. The allowance
method is used in providing for loan losses. Accordingly, all loan losses are
charged to the allowance and all recoveries are credited to it. The allowance
for loan losses is established through a provision for loan losses charged to
operations. The provision for loan losses is based on management's evaluation of
the collectibility of the loan portfolio, including past loan loss experience,
known and inherent risks in the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values, and economic
conditions.
At June 30, 1999, Security Federal had an allowance for loan losses of $1.5
million. Although management believes that it uses the best information
available to establish the allowance for loan losses, future adjustments to the
allowance for loan losses may be necessary and results of operations could be
significantly and adversely affected if circumstances differ substantially from
the assumptions used in making the determinations. Furthermore, while Security
Federal believes it has established its existing allowance for loan losses as
required by generally accepted accounting principles, there can be no assurance
that regulators, in reviewing Security Federal's loan portfolio, will not
request Security Federal to increase significantly its allowance for loan
losses. In addition, because future events affecting borrowers and collateral
cannot be predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not be
necessary should the quality of any loans deteriorate as a result of the factors
discussed above. Any material increase in the allowance for loan losses may
adversely affect Security Federal's financial condition and results of
operations.
53
The following table presents an analysis of Security Federal's allowance
for loan losses.
Year Ended June 30,
----------------------------------
1999 1998
------------ -------------
(Dollars in thousands)
Allowance for loan losses, beginning of period.............................. $ 1,289 $ 1,151
Charge-offs:
Real estate:
One- to four-family................................................... (69) (149)
Multi-family and commercial real estate............................... -- --
Construction.......................................................... (230) --
Consumer and other:
Automobile............................................................ (183) (101)
Home equity and second mortgage....................................... -- --
Other................................................................. (104) (82)
Commercial business...................................................... -- (93)
------- -------
Total charge-offs..................................................... (586) (425)
------- -------
Recoveries:
Real estate:
One- to four-family................................................... 1 10
Multi-family and commercial real estate............................... -- --
Construction.......................................................... -- --
Consumer and other:
Automobile............................................................ 7 2
Home equity and second mortgage....................................... -- --
Other................................................................. 8 1
Commercial business...................................................... -- --
------- -------
Total recoveries...................................................... 16 13
------- -------
Net charge-offs............................................................. (570) (412)
Provision for loan losses................................................... 750 550
------- -------
Allowance for loan losses, end of period.................................... $ 1,469 $ 1,289
======= =======
Net charge-offs to average interest-earning loans........................... (0.29)% (0.15)%
Allowance for loan losses to total loans.................................... 0.98 0.71
Allowance for loan losses to nonperforming loans............................ 69.72 43.83
Net charge-offs to beginning allowance for loan losses...................... 44.22 35.79
For additional discussion regarding the provisions for loan losses in
recent periods, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Comparison of Operating Results for the Years Ended
June 30, 1999 and 1998--Provision for Loan Losses."
54
The following table presents the approximate allocation of the allowance
for loan losses by loan category at the dates indicated. Management believes
that the allowance can be allocated by category only on an approximate basis.
The allocation of the allowance to each category is not necessarily indicative
of future losses and does not restrict the use of the allowance to absorb losses
in any other category.
At June 30,
----------------------------------------------------------------------------
1999 1998
--------------------------------- ---------------------------------------
Percent of Percent Percent of Percent
Allowance of Loans Allowance of Loans
in Each in Each in Each in Each
Category Category to Category Category to
to Total Total to Total Total
Amount Allowance(1) Loans(1) Amount Allowance(1) Loans(1)
------ ----------- ----------- ------ ------------ ------------
(Dollars in thousands)
Real estate loans:
One- to four-family............................ $ 668 45.47% 57.44% $ 593 46.00% 56.24%
Multi-family and commercial
real estate................................. 342 23.28 10.96 175 13.58 5.56
Construction................................... 7 0.48 4.28 56 4.34 7.14
Consumer loans and other:
Automobile..................................... 243 16.54 10.66 295 22.89 13.74
Home equity and second mortgage................ 50 3.40 11.66 42 3.26 11.38
Other.......................................... 9 0.62 1.08 51 3.96 1.29
Commercial business loans......................... 51 3.47 3.92 30 2.32 4.65
Unallocated....................................... 99 6.74 -- 47 3.65 --
------ ------ ------ ------ ------ ------
Total allowance for loan losses............. $1,469 100.00% 100.00% $1,289 100.00% 100.00%
====== ====== ====== ====== ====== ======
-----------------------------------------
(1) Excludes loans available for sale.
Securities Activities
Security Federal is permitted under federal law to invest in various types
of liquid assets, including U.S. Government obligations, securities of various
federal agencies and of state and municipal governments, deposits at the Federal
Home Loan Bank of Indianapolis, certificates of deposit of federally insured
institutions, certain bankers' acceptances and federal funds. Within certain
regulatory limits, Security Federal may also invest a portion of its assets in
commercial paper and corporate debt securities. Savings institutions like
Security Federal are also required to maintain an investment in Federal Home
Loan Bank of Indianapolis stock. Security Federal is required under federal
regulations to maintain a minimum amount of liquid assets. See "Regulation and
Supervision" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Liquidity and Capital Resources."
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," requires that securities be
categorized as "held to maturity," "trading securities" or "available for sale,"
based on management's intent as to the ultimate disposition of each security.
Statement of Financial Accounting Standards No. 115 allows debt securities to be
classified as "held to maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as "held
to maturity." Debt and equity securities held for current resale are classified
as "trading securities." These securities are reported at fair value, and
unrealized gains and losses on the securities would be included in earnings.
Security Federal does not currently use or maintain a trading account. Debt and
equity securities not classified as either "held to maturity" or "trading
securities" are classified as "available for sale." These securities are
reported at fair value, and unrealized gains and losses on the securities are
excluded from earnings and reported, net of deferred taxes, as a separate
component of equity. At June 30, 1999, all of Security Federal's mortgage-backed
securities and investment securities were classified as "available for sale."
55
All of Security Federal's securities carry market risk insofar as increases
in market rates of interest may cause a decrease in their market value. They
also carry prepayment risk insofar as they may be called before maturity in
times of low market interest rates, so that Security Federal may have to invest
the funds at a lower interest rate. Security Federal's investment policy permits
engaging in hedging activities directly related to its mortgage banking
activities. Investments are made based on certain considerations, which include
the interest rate, yield, settlement date and maturity of the investment,
Security Federal's liquidity position, and anticipated cash needs and sources.
The effect that the proposed investment would have on Security Federal's credit
and interest rate risk and risk-based capital is also considered. Security
Federal purchases securities to provide necessary liquidity for day-to-day
operations. Security Federal also purchases securities when investable funds
exceed loan demand.
The following table presents the amortized cost and fair value of Security
Federal's securities, by accounting classification and by type of security, at
the dates indicated.
At June 30,
---------------------------------------------------------
1999 1998
--------------------------- --------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ----------- -----------
(In thousands)
Securities available for sale:
Obligations of U.S. Treasury and U.S. government agencies........... $13,963 $13,893 $17,067 $17,055
------- ------- ------- -------
Mortgage-backed securities available for sale:
Fannie Mae............................................................. $ 1,441 $ 1,448 $ 3,293 $ 3,323
Freddie Mac............................................................ 2,529 2,532 3,469 3,471
------- ------- ------- -------
Total............................................................ 3,970 $ 3,980 6,762 $ 6,794
======= =======
Net unrealized gains (losses) on securities available for sale............ (60) 20
------- -------
Total securities available for sale........................... $17,873 $23,849
======= =======
All of Security Federal's mortgage-backed securities are issued or
guaranteed by agencies of the U.S. Government. Accordingly, they carry lower
credit risk than mortgage-backed securities of a private issuer. However,
mortgage-backed securities still carry market risk, the risk that increases in
market interest rates may cause a decrease in market value, and prepayment risk,
the risk that the securities will be repaid before maturity and that Security
Federal will have to reinvest the funds at a lower interest rate.
At June 30, 1999, Security Federal did not own any securities, other than
U.S. Government and agency securities, which had an aggregate book value in
excess of 10% of Security Federal's retained earnings at that date.
56
The following presents the activity in the mortgage-backed securities and
securities portfolios for the periods indicated.
Year Ended June 30,
-----------------------------------
1999 1998
------------- --------------
(In thousands)
Mortgage-backed securities (1):
Mortgage-backed securities, beginning of period..................... $ 6,794 $ 3,522
Purchases........................................................... -- 4,971
Sales............................................................... -- --
Repayments and prepayments.......................................... (2,792) (1,721)
Increase (decrease) in net premium.................................. -- --
Increase (decrease) in unrealized gain.............................. (22) 22
------ --------
Net increase (decrease) in mortgage-backed securities............. (2,814) 3,272
------ --------
Mortgage-backed securities, end of period............................ $ 3,980 $ 6,794
======= ========
Securities (2):
Securities, beginning of period...................................... $ 17,055 $ 11,007
Purchases............................................................ 30,009 24,692
Sales................................................................ -- --
Maturities and calls................................................. (33,380) (18,878)
Increase (decrease) in net premium................................... 217 225
Increase (decrease) in unrealized gain............................... (58) 9
-------- --------
Net increase (decrease) in securities............................. (3,162) 6,048
-------- --------
Securities, end of period............................................ $ 13,893 $ 17,055
======== ========
- ---------------------------------
(1) All mortgage-backed securities are classified as available for sale.
(2) All securities are classified as available for sale.
The following table presents certain information regarding the carrying
value (which equals fair value), weighted average yields and maturities or
periods to repricing of Security Federal's debt securities at June 30, 1999, all
of which are available for sale.
Less Than One to After Five to
One Year Five Years Ten Years
--------------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
--------------------------- ----------------------- -----------------------
(Dollars in thousands)
Securities available for sale:
Investment securities:
Obligations of the U.S.
Treasury and U.S.
government agencies............... $8,982 4.85% $4,911 5.74% -- --
Mortgage-backed securities............... -- -- 26 7.04 $1,757 7.00%
------ ------ ------
Total.............................. $8,982 4.85% $4,937 5.74% $1,757 7.00%
====== ====== ======
After
Ten Tears Totals
------------------------- -------------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
------------------------- -------------------------
(Dollars in thousands)
Securities available for sale:
Investment securities:
Obligations of the U.S.
Treasury and U.S.
government agencies..................... -- -- $13,893 5.18%
Mortgage-backed securities..................... $2,197 6.00% 3,980 6.44
------ -------
Total.................................... $2,197 6.00% $17,873 5.46%
====== =======
57
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for Security
Federal's lending and other investment activities. In addition, Security Federal
also generates funds internally from loan principal repayments and prepayments
and maturing investment securities. Scheduled loan repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are influenced significantly by general interest rates and money market
conditions. Security Federal may use borrowings from the Federal Home Loan Bank
of Indianapolis to compensate for reductions in the availability of funds from
other sources. Presently, Security Federal has no other borrowing arrangements
aside from Federal Home Loan Bank of Indianapolis advances.
Deposit Accounts. A majority of Security Federal's depositors reside in
Indiana and Illinois. Security Federal's deposit products include savings
accounts, checking and NOW accounts, certificates of deposit, individual
retirement accounts and money market accounts. Deposit account terms vary with
the principal differences being the minimum balance deposit, early withdrawal
penalties and the interest rate. Security Federal reviews its deposit mix and
pricing weekly. Security Federal does not utilize brokered deposits, and
currently does not and does not intend to solicit jumbo certificates of deposit
at rates above those available generally in the market.
Security Federal believes it is competitive in the interest rates it offers
on its deposit products. Security Federal determines the rates paid based on a
number of factors, including rates paid by competitors, Security Federal's need
for funds and cost of funds, borrowing costs and movements of market interest
rates. Historically, Security Federal has relied predominately on certificates
of deposit with terms of more than one year.
In the unlikely event Security Federal is liquidated after the conversion,
depositors will be entitled to full payment of their deposit accounts before any
payment is made to Security Financial as the sole stockholder of Security
Federal.
The following table indicates the amount of Security Federal's jumbo
certificates of deposit by time remaining until maturity as of June 30, 1999.
Jumbo certificates of deposits have principal balances of $100,000 or more.
Weighted
Average
Maturity Period Amount Rate
--------------- ------------- -----------
(In thousands)
Three months or less....................... $ 7,679 4.71%
Over three through six months.............. 2,852 4.72
Over six through twelve months............. 3,195 4.75
Over twelve months......................... 201 5.00
------- ----
Total.............................. $13,927 4.72%
======= ====
58
The following table presents information concerning average balances and
rates paid on Security Federal's deposit accounts at the dates indicated.
For the Year Ended June 30,
---------------------------------------------------------------------------------
1999 1998
----------------------------------- ----------------------------------------
Percent Percent
of Total of Total
Average Average Average Average Average Average
Balance Deposits Rate Paid Balance Deposits Rate Paid
--------- --------- ---------- --------- --------- ----------
(Dollars in thousands)
Savings accounts...................... $ 46,412 22.74% 2.47% $ 46,089 19.44% 2.83%
Money market accounts................. 6,232 3.05 2.65 6,699 2.83 2.99
NOW accounts.......................... 16,353 8.01 0.68 13,368 5.64 0.69
Certificates of deposit............... 124,857 61.19 5.15 158,891 67.03 5.81
Noninterest-bearing deposits:
Demand deposits.................... 10,209 5.01 -- 11,988 5.06 --
-------- ------ -------- ------
Total average deposits.......... $204,063 100.00% $237,035 100.00%
======== ====== ======== ======
Deposit Flow. The following table presents the balances, with interest
credited, and changes in dollar amounts of deposits in the various types of
accounts offered by Security Federal between the dates indicated.
Year Ended June 30,
---------------------------------------------------------------------------------------
1999 1998
-------------------------------------------------- ------------------------------
Percent Increase Percent
Amount of Total (Decrease) Amount of Total
--------- ---------- ------------- --------- -------------
(Dollars in thousands)
Savings accounts..................... $ 45,356 27.34% $ (1,592) $ 46,948 20.03%
Money market deposits................ 6,090 3.67 (467) 6,557 2.80
NOW accounts......................... 13,643 8.22 (1,028) 14,671 6.26
Fixed-rate certificates maturing:
Within 1 year...................... 80,016 48.24 (46,025) 126,041 53.78
After 1 year, but within 2 years... 11,856 7.14 (2,692) 14,548 6.21
After 2 years, but within 5 years.. 6,235 3.76 691 5,544 2.36
After 5 years..................... 1,461 0.88 (908) 2,369 1.01
-------- ------ -------- -------- ------
Total certificates............. 99,568 60.02 (48,934) 148,502 63.36
Noninterest-bearing deposits:
Demand deposits................... 1,237 0.75 (16,461) 17,698 7.55
-------- ------ -------- -------- ------
Total.......................... $165,894 100.00% $(68,482) $234,376 100.00%
======== ====== ======== ======== ======
59
Time Deposits by Rates and Maturities. The following table presents the
amount of time deposits in Security Federal categorized by rates and maturities
at the dates indicated.
Period to Maturity from June 30, 1999 At June 30,
------------------------------------------------------------------ ------------------------------
Less than 1 - 2 2 - 3 3 - 4 After
One Year Years Years Years 4 Years Total 1999 1998
-------- --------- -------- --------- --------- --------- ------------- --------------
(Dollars in thousands)
0.00 - 4.00%............. $ 78 $ -- $ -- $ -- $ 12 $ 90 $ 90 $ 255
4.01 - 5.00%............. 58,691 6,375 938 -- 384 66,388 66,388 4,386
5.01 - 6.00%............. 16,829 4,127 1,928 590 1,065 24,539 24,539 124,424
6.01 - 7.00%............. 4,169 1,291 829 1,836 -- 8,125 8,125 18,852
Over 7.00%............... 249 63 81 33 -- 426 426 585
------- ------- ------ ------ ------ ------- ------- --------
Total................. $80,016 $11,856 $3,776 $2,459 $1,461 $99,568 $99,568 $148,502
======= ======= ====== ====== ====== ======= ======= ========
Deposit Activity. The following table presents the deposit activity of
Security Federal for the periods indicated.
Year Ended June 30,
-----------------------------------
1999 1998
-------------- --------------
(In thousands)
Beginning balance............................. $234,376 $183,489
Net deposits (withdrawals) before interest
credited................................... (75,318) 41,997
Interest credited............................. 6,836 8,890
-------- --------
Net increase (decrease) in deposits........... (68,482) 50,887
-------- --------
Ending balance............................. $165,894 $234,376
======== ========
Borrowings. Security Federal has the ability to use advances from the
Federal Home Loan Bank of Indianapolis to supplement its supply of lendable
funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank of
Indianapolis functions as a central reserve bank providing credit for savings
associations and certain other member financial institutions. As a member of the
Federal Home Loan Bank of Indianapolis, Security Federal is required to own
capital stock in the Federal Home Loan Bank of Indianapolis and is authorized to
apply for advances on the security of the capital stock and certain of its
mortgage loans and other assets, principally securities that are obligations of,
or guaranteed by, the U.S. Government or its agencies, provided certain
creditworthiness standards have been met. Advances are made under several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At June 30, 1999, Security
Federal had the ability to borrow a total of approximately $71.0 million from
the Federal Home Loan Bank of Indianapolis. At that date, Security Federal had
outstanding advances of $5.0 million.
60
The following tables presents certain information regarding Security
Federal's use of Federal Home Loan Bank of Indianapolis advances during the
periods and at the dates indicated.
Year Ended June 30,
--------------------------------
1999 1998
----------- ------------
(Dollars in thousands)
Maximum amount of advances outstanding at any month end............................. $32,466 $85,469
Approximate average advances outstanding............................................ 25,749 74,904
Approximate weighted average rate paid on advances.................................. 6.11% 6.19%
--------------------------------
At June 30,
--------------------------------
1999 1998
------------ ------------
(Dollars in thousands)
Balance outstanding at end of period............................................... $5,000 $31,815
Weighted average rate paid on advances............................................. 5.54% 6.18%
Trust Services
In 1997, Security Federal established a Trust Services department within
Security Federal which provides trust and investment services to individuals,
partnerships, corporations and institutions. Security Federal believes that the
trust department allows it to provide investment opportunities and fiduciary
services to both current and prospective customers. Consistent with Security
Federal's operating strategy, Security Federal will continue to emphasize the
growth of its trust service operations to grow assets and increase fee-based
income. Security Federal has implemented several policies governing the
practices and procedures of the trust department, including policies relating to
maintaining confidentiality of trust records, investment of trust property,
handling conflicts of interest, and maintaining impartiality. At June 30, 1999,
the trust department managed 240 accounts with aggregate assets of $9.6 million.
The trust department is monitored by the Board of Directors' Trust Committee.
Subsidiary Activities
The following are descriptions of Security Federal's wholly owned
subsidiaries, which following the conversion will be indirectly owned by
Security Financial.
The Boulevard, Inc. The Boulevard, Inc. was originally formed in 1970 but
later became inactive until 1999. It currently operates as a wholly owned
service corporation of Security Federal. Boulevard is a certified insurance
agent and currently acts as a sub-agent for other insurance agencies, offering
insurance products including property and casualty and life and health
insurance. Boulevard also intends to offer financial services in the near
future.
Other Subsidiaries. Security Federal has two other wholly owned
subsidiaries: Strategic Financial Corp. and Family Home Service Corp. Strategic
Financial and Family Home have both been inactive since 1997.
61
Properties
The following table sets forth Security Federal's offices, as well as
certain additional information relating to these offices, as of June 30, 1999.
Original Date of Net Book
Lease or Date Leased Lease Value of
Location Owned or Owned Expiration Property(1)
- -------- -------- ----------- ---------- -----------
Main Office:
9321 Wicker Avenue Owned 1988 $4,032,000
St. John, Indiana 46373
BRANCH OFFICES:
2930 Ridge Road Leased 1997 2019 271,000
Highland, Indiana 46322
2090 E. Commercial Avenue Leased 1997 2012 176,000
Lowell, Indiana 46356
370 W. 80th Place Leased 1997 2012 30,000
Merrillville, Indiana 46410
7007 Calumet Avenue Owned 1992 195,000
Hammond, Indiana 46324
4518 Indianapolis Avenue Leased 1992 2002 153,000
East Chicago, Indiana 46312
552A Indian Boundary Road Leased 1997 2007 91,000
Chesterton, Indiana 46304
________________________________
(1) Represents the net book value of land, buildings, furniture, fixtures and
equipment owned by Security Federal.
Security Federal also owns properties in Winfield Township, Highland and
East Chicago all located in Lake County, Indiana. The net book value of these
properties as of June 30, 1999 was $325,000, $312,000 and $22,000, respectively.
Personnel
As of June 30, 1999, Security Federal had 84 full-time employees and 27
part-time employees, none of whom is represented by a collective bargaining
unit. Security Federal believes its relationship with its employees is good.
Legal Proceedings
Periodically, there have been various claims and lawsuits involving
Security Federal, such as claims to enforce liens, condemnation proceedings on
properties in which Security Federal holds security interests, claims involving
the making and servicing of real property loans and other issues incident to
Security Federal's business. Security Federal is not a party to any pending
legal proceedings that it believes would have a material adverse effect on the
financial condition or operations of Security Federal.
62
MANAGEMENT OF SECURITY FINANCIAL
Directors shall be elected by the stockholders of Security Financial for
staggered three-year terms, or until their successors are elected and qualified.
Security Financial's Board of Directors consists of nine persons divided into
three classes, each of which contains approximately one third of the Board. One
class, consisting of John P. Hyland, Tula Kavadias and Philip T. Rueth, has a
term of office expiring at the first annual meeting of stockholders after their
initial election by stockholders; a second class, consisting of Mary Beth
Bonaventura, Lawrence R. Parducci and Robert A. Vellutini, has a term of office
expiring at the second annual meeting of stockholders after their initial
election by stockholders; and a third class, consisting of Howard O. Cyrus, Sr.,
Dr. Peter Ferrini and Robert L. Lauer, has a term of office expiring at the
third annual meeting of stockholders after their initial election by
stockholders.
The executive officers of Security Financial are elected annually and hold
office until their respective successors have been elected and qualified or
until death, resignation or removal by the Board of Directors. The executive
officers of Security Financial are:
Name Position
---- --------
John P. Hyland President and Chief Executive Officer
James H. Foglesong Executive Vice President and Chief Financial Officer
Lawrence R. Parducci Corporate Secretary
Since the formation of Security Financial, none of the executive officers,
directors or other personnel has received remuneration from Security Financial.
For information concerning the principal occupations, employment and
compensation of the directors and executive officers of Security Financial
during the past five years, see "Management of Security Federal-Biographical
Information."
63
MANAGEMENT OF SECURITY FEDERAL
Directors and Executive Officers
The Board of Directors of Security Federal is presently composed of nine
members who are elected for terms of three years, approximately one third of
whom are elected annually as required by the Bylaws of Security Federal. The
executive officers of Security Federal are elected annually by the Board of
Directors and serve at the Board's discretion. The following table presents
information with respect to the directors and executive officers of Security
Federal.
Directors
Name Age (1) Position Held With Security Federal Since Expires
- ---- ------- ----------------------------------- -------- -------
John P. Hyland 48 Director, President and Chief Executive Officer 1999 2000
Tula Kavadias 42 Director 1997 2000
Philip T. Rueth 53 Director 1997 2000
Mary Beth Bonaventura 44 Chairman of the Board 1992 2001
Lawrence R. Parducci 68 Vice Chairman of the Board 1988 2001
Robert A. Vellutini 54 Director 1999 2001
Howard O. Cyrus, Sr. 61 Director 1996 2002
Dr. Peter Ferrini 75 Director 1977 2002
Robert L. Lauer 44 Director 1998 2002
Dr. AP Bonaventura 80 Director Emeritus 1957 (2)
- ---------------------------------
(1) As of June 30, 1999.
(2) Dr. Bonaventura retired as Chairman of the Board in 1998.
Executive Officers Who Are Not Directors
Name Age (1) Position Held With Security Federal
- ----- --------- ------------------------------------
James H. Foglesong 53 Executive Vice President and Chief Financial
Officer
Joann Duhon 42 Executive Vice President, Retail Banking
John F. Nicholas 35 Executive Vice President, Mortgage Banking
Kevin Dunn 45 Executive Vice President, Audit/CRA/Compliance
Joann Halterman 42 Vice President, Human Resources/Marketing
Kent R. Huntoon 35 Vice President, The Boulevard, Inc.
Thomas W. Baranko 30 Assistant Vice President, Trust and Trust Officer
- ---------------------------------
(1) As of June 30, 1999.
Biographical Information
Below is certain information regarding the directors and executive officers
of Security Federal. Unless otherwise stated, each director and executive
officer has held his or her current occupation for the last five years.
John P. Hyland has served as President and Chief Executive Officer of
Security Federal since October 1998. Prior to joining Security Federal, Mr.
Hyland served as Director, President and Chief Executive Officer of Southwest
Financial Bank and Trust, Orland Park, Illinois, and as Director and Vice
President for Southwest Financial Corporation, the holding company for Southwest
Financial Bank and Trust.
64
Tula Kavadias is an attorney admitted to the Bar of the State of Indiana.
Ms. Kavadias is the sole proprietor of the law firm of Tula Kavadias &
Associates.
Philip T. Rueth is a certified public accountant for Steiber, Rueth & Co.,
a certified public accounting firm. Mr. Rueth is also a registered
representative for Terra Securities Corporation, a broker dealer.
Mary Beth Bonaventura is a Senior Judge of the Lake Superior Court,
Juvenile Division. Ms. Bonaventura was elected as Chief Judge of the Lake
Superior Courts for the 1997-1998 term. Ms. Bonaventura is the daughter of Dr.
Bonaventura.
Lawrence R. Parducci is a pharmacist, consultant and pharmacy insurance
solicitor for Fagen Pharmacy, a 20-store pharmacy chain.
Robert A. Vellutini is a Vice President of Investments for A.G. Edwards &
Sons, Inc., a financial services and brokerage firm. Mr. Vellutini participates
in this offering solely in his individual capacity, is not acting as a broker in
this offering, and this offering is not associated in any manner with A.G.
Edwards & Sons, Inc. Mr. Vellutini's participation herein is not to be construed
as a solicitation or endorsement by A.G. Edwards & Sons, Inc. A.G. Edwards &
Sons, Inc. has not performed any due diligence, expresses no opinion and makes
no recommendation regarding participation in this offering. Mr. Vellutini is the
first cousin of Dr. Ferrini.
Howard O. Cyrus, Sr. is the owner of and real estate broker for Cyrus
Realtors, Inc., a corporation specializing in the sales, leasing, appraisals and
management of commercial/industrial properties.
Dr. Peter Ferrini is a retired oral surgeon. Dr. Ferrini is the uncle of
Mr. Lauer and is the first cousin of Mr. Vellutini and Dr. Bonaventura.
Robert L. Lauer is a Vice President of Investments and Assistant Branch
Manager for A.G. Edwards & Sons, Inc. a financial services and brokerage firm.
Mr. Lauer participates in this offering solely in his individual capacity, is
not acting as a broker in this offering, and this offering is not associated in
any manner with A.G. Edwards & Sons, Inc. Mr. Lauer's participation herein is
not to be construed as a solicitation or endorsement by A.G. Edwards & Sons,
Inc. A.G. Edwards & Sons, Inc. has not performed any due diligence, expresses no
opinion and makes no recommendation regarding participation in this offering.
Mr. Lauer is the nephew of Dr. Ferrini.
Dr. AP Bonaventura served as Chairman of the Board from 1957 to November
1998. Dr. Bonaventura is a retired physician. Dr. Bonaventura is the father of
Ms. Bonaventura and the first cousin of Dr. Ferrini.
Executive Officers Who Are Not Directors
James H. Foglesong has served as Executive Vice President and Chief
Financial Officer of Security Federal since November 1995. Prior to joining
Security Federal, Mr. Foglesong served as Executive Vice President and Chief
Financial Officer of First of America Bank Northwest Indiana, LaPorte, Indiana.
Joann Duhon joined Security Federal in 1996 as Assistant Vice President,
Regional Branch Manager. In July, 1997, Ms. Duhon was appointed Executive Vice
President, Retail Banking. Prior to joining Security Federal, Ms. Duhon was a
Branch Manager for Peoples Bank, East Chicago.
John F. Nicholas joined Security Federal in May 1996 as a Staff Appraiser
and in November 1996 was appointed to Assistant Vice President and CRA Officer.
In 1997, Mr. Nicholas was appointed Manager, Residential Construction Lending.
In 1998, Mr. Nicholas was appointed Executive Vice President, Mortgage Banking.
Prior to joining Security Federal, Mr. Nicholas was a real estate appraiser with
Richard Adomatis & Associates.
65
Kevin Dunn joined Security Federal in 1996 as an Assistant Vice President.
In May 1998, Mr. Dunn was appointed Interim President and Chief Executive
Officer, a position in which he served until October 1998. Since October 1998,
Mr. Dunn has served as Executive Vice President, Audit/CRA/Compliance. Prior to
joining Security Federal, Mr. Dunn was a Certified Thrift Examiner with the
Office of Thrift Supervision, Central Region.
Joann Halterman joined Security Federal in 1976 as a Teller. In 1998, Ms.
Halterman was appointed as Assistant Vice President, Human Resources and in
February 1999 was appointed Vice President, Human Resources/Marketing.
Kent R. Huntoon joined Security Federal in 1996 as Retail Sales Manager,
Trust Officer and Insurance Manager and Vice President and General Manager of
The Boulevard, Inc., a wholly owned subsidiary of Security Federal. Prior to
joining Security Federal, Mr. Huntoon served as a registered representative of
Prudential Insurance Co. of America.
Thomas W. Baranko has served as Assistant Vice President, Trust and Trust
Officer of Security Federal since April 1997. Prior to joining Security Federal,
Mr. Baranko served as Trust Officer of Sand Ridge Bank, Highland, Indiana.
Meetings and Committees of the Board of Directors of Security Federal and
Security Financial
The business of Security Federal is conducted through meetings and
activities of the Board of Directors and its committees. During the fiscal year
ended June 30, 1999, the Board of Directors held 12 regular meetings and 11
special meetings. No director attended fewer than 75% of the total meetings of
the Board of Directors and committees on which the director served.
The Loan Committee consists of Ms. Bonaventura, Dr. Ferrini, Mr. Cyrus, Mr.
Vellutini and Ms. Kavadias. This committee reviews and approves loan
applications that do not require the approval of the full Board of Directors.
The committee meets on a monthly basis.
The Audit/Accounting/CRA/OTS Examinations Committee consists of Ms.
Bonaventura, Dr. Ferrini, Mr. Lauer, Ms. Kavadias and Mr. Rueth. The committee
receives and reviews all reports prepared by Security Federal's external
auditor. In addition, this committee reviews all Community Reinvestment Act and
Office of Thrift Supervision examination reports. The committee meets on a
quarterly basis.
The Asset Liability/Investment Committee consists of Ms. Bonaventura, Mr.
Rueth, Dr. Ferrini, Mr. Vellutini and Mr. Lauer. The committee reviews and
classifies Security Federal's loans and other assets according to established
policies of the Board of Directors. The committee meets on a monthly basis.
The Trust Committee consists of Ms. Bonaventura, Mr. Rueth, Dr. Ferrini and
Ms. Kavadias. This committee oversees Security Federal's trust activities,
including the review and approval of the trust department's policies, the
coordination of an annual trust department audit and the review of examination
reports of the trust department. This committee meets on a quarterly basis.
The Personnel and Compensation Committee consists of Ms. Bonaventura, Mr.
Parducci, Mr. Rueth and Ms. Kavadias. This committee is responsible for all
matters regarding employee compensation and benefit programs. This committee
meets on a quarterly basis.
The Executive Committee consists of Ms. Bonaventura, Mr. Parducci, Mr.
Lauer and Ms. Kavadias. This committee evaluates issues of major importance to
Security Federal between regularly scheduled Board meetings. This committee
meets as needed.
The Board of Directors has also established the following committees:
Nominating Committee; Technology/Y2K Committee; the Insurance Board Center
Committee; and the Facilities Committee.
66
The Board of Directors of Security Financial has established an Audit
Committee consisting of Ms. Bonaventura, Mr. Hyland, Ms. Kavadias, Mr. Rueth and
Mr. Vellutini, a Compensation Committee consisting of Ms. Bonaventura, Mr.
Cyrus, Mr. Hyland, Mr. Lauer and Mr. Parducci, a Pricing Committee consisting of
the entire Board of Directors, and a Nominating Committee consisting of Ms.
Bonaventura, Dr. Ferrini, Mr. Hyland, Mr. Lauer and Mr. Parducci.
Directors' Compensation
Meeting Fees. Security Federal pays a fee to each of its non-management
directors for attendance at each board meeting and each meeting of a committee
of which they are members. The following table sets forth the meeting fees in
effect for the fiscal year ended June 30, 1999:
Fees
----
Regular Board Meetings
Chairman...................... $2,000
Vice-Chairman................. $1,600
Director...................... $1,000
Director Emeritus............. $ 500
Special Board Meetings:
All Day Session............... $ 500
Regular Session............... $ 250
Committee Meetings............. $ 250
After the conversion, Security Federal will continue to pay directors fees
and Security Financial expects to pay an annual retainer of $2,500 for service
on its Board of Directors.
Director's Retirement Plan. Security federal maintains a retirement program
for incumbent nonemployee directors to provide a retirement income supplement
for directors. Current directors will receive an annual benefit of approximately
$1,000 for each year of service at the normal retirement age of 65.
Other Director Compensation. All directors receive medical and dental
benefits.
Executive Compensation
Summary Compensation Table. The following information is furnished for Mr.
Hyland and Mr. Dunn for the fiscal year ended June 30, 1999. Mr. Dunn served as
Interim President and Chief Executive Officer from May 1998 to October 1998. Mr.
Hyland became employed in October 1998. No other executive officer of Security
Federal received salary and bonus of $100,000 or more during the fiscal year
ended June 30, 1999.
Annual Compensation (1)
-----------------------
Name and Other Annual All Other
Position Year Salary Bonus Compensation (2) Compensation
- -------- ---- ------ ----- ---------------- ------------
John P. Hyland........ 1999 $134,778 -- -- --
Kevin Dunn............ 1999 85,805 -- -- --
________________
(1) Compensation information for the fiscal years ended June 30, 1998 and 1997
has been omitted as Security Federal was neither a public company nor a
subsidiary of a public company at that time.
(2) Does not include the aggregate amount of perquisites and other personal
benefits, which was less than 10% of the total annual salary and bonus
reported.
67
Employment Agreements. Effective September 18, 1998, Security Federal
entered into an employment agreement with Mr. Hyland. This agreement will be
terminated upon conversion and replaced with a new agreement. Upon the
completion of the conversion, Security Federal and Security Financial each
intend to enter into employment agreements with Mr. Hyland (the "Executive")
(collectively, the "Employment Agreements"). The Employment Agreements are
intended to ensure that Security Federal and Security Financial will be able to
maintain a stable and competent management base after the conversion. Mr. Hyland
intends to enter into these agreements upon consummation of the conversion. The
continued success of Security Federal and Security Financial depends to a
significant degree on the skills and competence of Mr. Hyland.
The Employment Agreements will provide for a three-year term. The term of
the Security Financial Employment Agreement shall be extended on a daily basis
unless written notice of non-renewal is given by the Board of Directors and the
term of Security Federal Employment Agreements shall be renewable on an annual
basis. The Employment Agreements provide that the Executive's base salary will
be reviewed annually. The base salary which will be effective for such
Employment Agreements for Mr. Hyland, will be $175,000. In addition to the base
salary, the Employment Agreements provide for, among other things, participation
in stock benefits plans and other fringe benefits applicable to executive
personnel. The Employment Agreements provide for termination by Security Federal
or Security Financial for cause, as defined in the Employment Agreements, at any
time. If Security Federal or Security Financial chooses to terminate the
Executive's employment for reasons other than for cause, or if the Executive
resigns from Security Federal or Security Financial after a: (1) failure to re-
elect the Executive to his current offices; (2) material change in the
Executive's functions, duties or responsibilities; (3) relocation of the
Executive's principal place of employment by more than 25 miles; (4) reduction
in the benefits and perquisites being provided to the Executive in the
Employment Agreement; (5) liquidation or dissolution of Security Federal or
Security Financial; or (6) breach of the Employment Agreement by Security
Federal or Security Financial; the Executive or, if the Executive dies, his
beneficiary, would be entitled to receive an amount equal to the remaining base
salary payments due to the Executive for the remaining term of the Employment
Agreement and the contributions that would have been made on the Executive's
behalf to any employee benefit plans of Security Federal and Security Financial
during the remaining term of the Employment Agreement. Security Federal and
Security Financial would also continue and/or pay for the Executive's life,
health, dental and disability coverage for the remaining term of the Employment
Agreement. Upon termination of the Executive for reasons other than a change in
control, the Executive must adhere to a one year non-competition agreement.
Under the Employment Agreements, if voluntary or involuntary termination
follows a change in control of Security Federal or Security Financial, the
Executive or, if the Executive dies, his beneficiary, would be entitled to a
severance payment equal to the greater of: (1) the payments due for the
remaining term of the agreement; or (2) three times the average of the five
preceding taxable years' annual compensation. Security Federal and Security
Financial would also continue the Executive's life, health, and disability
coverage for thirty-six months. Even though both Security Federal and Security
Financial Employment Agreements provide for a severance payment if a change in
control occurs, the Executive would only be entitled to receive a severance
payment under one agreement. The Executive would also be entitled to receive an
additional tax indemnification payment if payments under the Security Financial
Employment Agreement or otherwise triggered liability under the Internal Revenue
Code for the excise tax applicable to "excess parachute payments." Under
applicable law, the excise tax is triggered by change in control-related
payments which equal or exceed three times the Executive's average annual
compensation over the five years preceding the change in control. The excise tax
equals 20% of the amount of the payment in excess of one times the Executive's
average compensation over the preceding five-year period. If a change in control
of Security Federal and Security Financial occurred, the total amount of
payments due under the Employment Agreements, based solely on the Executive's
fiscal 1999 cash compensation (and without regard to future base salary
adjustments or bonuses and excluding any benefits under any employee benefit
plan which may be payable) would be approximately $525,000.
Payments to the Executive under Security Federal's Employment Agreement
will be guaranteed by Security Financial if payments or benefits are not paid by
Security Federal. Payment under Security Financial's Employment Agreement would
be made by Security Financial. All reasonable costs and legal fees paid or
incurred by the Executive under any dispute or question of interpretation
relating to the Employment Agreements shall be paid by Security Federal or
Security Financial, respectively, if the Executive is successful on the merits
in a legal judgment, arbitration or
68
settlement. The Employment Agreements also provide that Security Federal and
Security Financial shall indemnify the Executive to the fullest extent legally
allowable.
Employee Severance Compensation Plan. Security Federal's Board of Directors
intends to adopt a Security Federal employee severance compensation plan in
connection with the conversion to provide benefits to eligible employees upon a
change in control of Security Financial or Security Federal. Eligible employees
are those with a minimum of one year of service with Security Federal.
Generally, all eligible employees, other than individuals who enter into
separate employment agreements with Security Financial and Security Federal,
will be eligible to participate in the severance plan. Under the severance plan,
if a change in control of Security Financial or Security Federal occurs,
eligible employees who are terminated or who terminate employment, but only upon
the occurrence of events specified in the severance plan, within 12 months of
the effective date of a change in control will be entitled to a severance
payment based on the individual's compensation and years of service. Generally,
the severance benefit equals two weeks compensation for each year of service up
to a maximum of 12 months compensation, provided, however, officers with a title
of vice president or greater will be entitled to a minimum benefit equal to six
months' compensation. Assuming that a change in control had occurred at June 30,
1999, and resulted in the termination of all eligible employees, the maximum
aggregate payment due under the severance plan would be approximately $1.0
million.
Benefits
Pension Plan. Security Federal participates in a multiple-employer defined
benefit pension plan known as the Financial Institutions Retirement Fund.
Generally, salaried employees of Security Federal become members of the Pension
Plan upon the completion of 1 year of service with Security Federal (as
described in the plan document adopted by Security Federal) and the attainment
of age 21. Security Federal makes annual contributions to the Financial
Institutions Retirement Fund sufficient to fund retirement benefits for its
employees, as determined in accordance with a formula set forth in the plan
document. Participants generally become vested in their accrued benefits under
the Pension Plan after completing 5 years of vesting service (as described in
the plan document). In general, accrued benefits under the pension plan,
including reduced benefits payable upon early retirement or in the event of a
disability, are based on an individual's years of benefit service (as described
in the plan document) and the average of the individual's highest five years'
salary (as described in the plan document). A participant's normal amount of
retirement benefit equals 2% multiplied by his years of benefit service
multiplied by his high five-year average salary.
401(k) Plan. Security Federal sponsors the Security Federal Bank 401(k)
Profit Sharing Plan for a tax-qualified profit sharing plan with a qualified
cash or deferred arrangement under Section 401(k) of the Internal Revenue Code,
for the benefit of its eligible employees. The 401(k) Plan provides participants
with savings and retirement benefits based on employee deferrals of
compensation. Eligible employees may begin participating in the 401(k) Plan on
the first day of the calendar month following the day they begin employment with
Security Federal. Participants may make annual salary reduction contributions to
the 401(k) Plan in amounts up to 15% of their compensation, within a legally
permissible limit ($10,000 for 1999). A participant is always 100% vested in his
or her elective deferrals of compensation under the 401(k) Plan. Security
Federal does not currently make matching contributions or other employer-
provided contributions to the 401(k) Plan.
Currently, participants may invest their accounts under the 401(k) Plan in
and among several funds with varying investment characteristics. Security
Federal intends to add, as an investment option, an employer stock fund in which
participants may invest all or a portion of their account balances primarily in
Security Financial common stock, within the limitations set forth in the plan
document. In connection with the conversion, a participant's ability to invest
in the employer stock fund is based on his or her status as an eligible account
holder or supplemental eligible account holder in the conversion. Regardless of
the source of funds, no eligible account holders or supplemental eligible
account holders may elect to invest in excess of $200,000 in common stock.
Generally, distributions from the 401(k) Plan may commence upon a
participant's separation from service for any reason. However, participants may
request in-service distributions from the 401(k) Plan in the form of hardship
69
withdrawals and loans. Distributions from the 401(k) Plan are generally subject
to federal and state income taxes and distributions made before a participant
attains age 59 1/2 may also be subject to a federal excise tax.
Employee Stock Ownership Plan. In connection with the conversion, Security
Federal's Board of Directors has authorized the adoption of an employee stock
ownership plan for employees of Security Federal. Generally, salaried employees
of Security Financial and Security Federal will become eligible to participate
in the ESOP upon the completion of one year of service and attainment of age 21;
provided, however, that all salaried employees employed at the date of the
conversion will immediately become participants in the plan.
Security Financial intends for the trustee of the ESOP to purchase 8% of
the shares issued in the conversion. This would range between 125,800 shares,
assuming 1,572,500 shares are issued in the conversion, and 170,200 shares
assuming 2,415,000 shares are issued in the conversion. It is anticipated that
the employee stock ownership plan will borrow funds from Security Financial to
purchase the stock in the conversion. The loan will equal 100% of the aggregate
purchase price of the common stock. The loan to the employee stock ownership
plan will be repaid principally from Security Federal's contributions to the
employee stock ownership plan and dividends payable on common stock held by the
employee stock ownership plan over the anticipated 15-year term of the loan. The
interest rate for the employee stock ownership plan loan is expected to be the
prime rate as published in The Wall Street Journal on the closing date of the
conversion. See "Pro Forma Data." If the employee stock ownership plan is unable
to acquire 8% of the common stock sold in the offering, it is anticipated that
additional shares may be acquired following the conversion through open market
purchases.
In any plan year, Security Federal may make additional discretionary
contributions (beyond those necessary to satisfy the loan obligation) to the
ESOP for the benefit of plan participants in either cash or shares of common
stock, which may be acquired through the purchase of outstanding shares in the
market or from individual stockholders or which constitute authorized but
unissued shares or shares held in treasury by Security Financial. The timing,
amount, and manner of discretionary contributions will be affected by several
factors, including applicable regulatory policies, the requirements of
applicable laws and regulations, and market conditions.
Shares purchased by the employee stock ownership plan with the proceeds of
the loan will be held in a suspense account and released on a pro rata basis as
the loan is repaid. Discretionary contributions to the employee stock ownership
plan and shares released from the suspense account will be allocated among
participants on the basis of each participant's proportional share of total
compensation. Any forfeitures will be reallocated among the remaining plan
participants.
Participants will vest in their accrued benefits under the employee stock
ownership plan at the rate of 20% per year of service, beginning upon the
completion of one year of service. Participants who are employed at the
effective date of the conversion will be fully vested in their accounts. A
participant will also become fully vested at retirement, upon death or
disability, a change in control or upon termination of the employee stock
ownership plan. Benefits are generally distributable upon a participant's
separation from service. Security Federal's contributions to the employee stock
ownership plan are not fixed, so benefits payable under the employee stock
ownership plan cannot be estimated.
It is anticipated that members of Security Federal's Board of Directors
will serve as trustees of the employee stock ownership plan or that Security
Federal will appoint an independent trustee. The trustees vote all allocated
shares held in the employee stock ownership plan as instructed by the plan
participants and unallocated shares and allocated shares for which no
instructions are received must be voted in the same ratio on any matter as those
shares for which instructions are given, subject to the fiduciary
responsibilities of the trustee.
Under applicable accounting requirements, compensation expense for a
leveraged employee stock ownership plan is recorded at the fair market value of
the employee stock ownership plan shares when committed to be released to
participants' accounts. See "Pro Forma Data."
70
The employee stock ownership plan must meet the requirements of the
Employee Retirement Income Security Act of 1974, as amended, and the regulations
of the Internal Revenue Service and the Department of Labor. Security Federal
intends to request a determination letter from the Internal Revenue Service
regarding the tax-qualified status of the employee stock ownership plan.
Security Federal expects to receive a favorable determination letter, but cannot
guarantee it.
Supplemental Executive Retirement Plan. Upon conversion, Security Federal
intends to implement a new plan to provide for supplemental benefits with
respect to the employee stock ownership plan benefits otherwise limited by other
provisions of the Internal Revenue Code. Specifically, the new plan will provide
benefits to eligible individuals (designed by the Board of Directors of Security
Federal or its affiliates) that cannot be provided under the employee stock
ownership plan as a result of the limitations imposed by the Internal Revenue
Code, but that would have been provided under the employee stock ownership plan
but for such limitations. An individual's benefits under the supplemental
executive retirement plan will generally become payable at the same time
benefits become payable under the employment stock ownership plan.
Security Federal may establish a grantor trust in connection with the new
supplemental executive retirement plan to satisfy the obligations of Security
Federal with respect to the supplemental executive retirement plan. The assets
of the grantor trust would remain subject to the claims of Security Federal's
general creditors in the event of Security Federal's insolvency until paid to
the individual pursuant to the terms of the supplemental executive retirement
plan.
Stock-Based Incentive Plan. Following the conversion, the Board of
Directors of Security Financial intends to adopt a stock-based incentive plan
(the "Stock-Based Incentive Plan") which will provide for the granting of
options to purchase common stock ("Stock Options") and restricted stock ("Stock
Awards"), to eligible officers, employees, and directors of Security Financial
and Security Federal. If the Stock-Based Incentive Plan is adopted within one
year after conversion, applicable regulations require such plan to be approved
by a majority of Security Financial's stockholders at a meeting of stockholders
to be held no earlier than six months after the completion of the conversion.
Under the Stock-Based Incentive Plan, Security Financial intends to grant
Stock Options in an amount equal to 10% of the shares of common stock issued in
the conversion. The amount granted would range from 157,250 shares, assuming
1,572,500 shares are issued in the conversion to 212,750 shares, assuming
2,127,500 shares are issued in the conversion. Additionally, Security Financial
intends to grant Stock Awards in an amount equal to 4% of the shares of common
stock issued in the conversion. The amount granted would range from 62,900
shares, assuming 1,572,500 shares are issued in the conversion to 85,100 shares,
assuming 2,127,500 shares are issued in the conversion. Any common stock awarded
under the Stock-Based Incentive Plan will be awarded at no cost to the
recipients. The plan may be funded through the purchase of common stock by a
trust established in connection with the Stock-Based Incentive Plan or from
authorized but unissued shares. Security Financial intends to appoint an
independent fiduciary to serve as trustee of a trust to be established in
connection with the Stock-Based Incentive Plan. If additional authorized but
unissued shares are acquired by the Stock-Based Incentive Plan after the
conversion, the interests of existing shareholders would be diluted. See "Pro
Forma Data."
The grants of Stock Options and Stock Awards will be designed to attract
and retain qualified personnel in key positions, provide officers and key
employees with a proprietary interest in Security Financial as an incentive to
contribute to the success of Security Financial and reward key employees for
outstanding performance. All employees of Security Financial and its
subsidiaries, including Security Federal, will be eligible to participate in the
Stock-Based Incentive Plan. It is expected that the committee administering the
plan will determine the terms of awards granted to officers and employees. The
committee will also determine whether Stock Options will be Incentive or Non-
Statutory Stock Options, as defined below, the number of shares available for
each Stock Option and Stock Award, the exercise price of each Non-Statutory
Stock Option, whether Stock Options may be exercised by delivering other shares
of common stock, and when Stock Options become exercisable or Stock Awards vest.
Only employees may receive grants of Incentive Stock Options. Therefore, under
the Stock-Based Incentive Plan, directors may receive only grants of Non-
Statutory Stock Options. If such plan is adopted within one year after
conversion, applicable regulations provide that no individual officer or
employee of Security Federal may receive more than 25% of the stock options
available under
71
the Stock-Based Incentive Plan (or any separate plan for officers and employees)
and non-employee directors may not receive more than 5% individually, or 30% in
the aggregate, of the stock options available under the Stock-Based Incentive
Plan (or any separate plan for directors). Federal regulations also provide that
no individual officer or employee of Security Federal may receive more than 25%
of the restricted stock awards available under the Stock-Based Incentive Plan
(or any separate plan for officers and employees) and non-employee directors may
not receive more than 5% individually, or 30% in the aggregate, of the
restricted stock awards available under the Stock-Based Incentive Plan (or any
separate plan for directors).
The Stock-Based Incentive Plan will provide for the grant of: (1) Stock
Options intended to qualify as Incentive Stock Options under Section 422 of the
Internal Revenue Code ("Incentive Stock Options"); and (2) Stock Options that do
not so qualify ("Non-Statutory Stock Options"). It is anticipated that all Stock
Options granted contemporaneously with stockholder approval of the Stock-Based
Incentive Plan will qualify as Incentive Stock Options to the extent permitted
under Section 422 of the Internal Revenue Code. Unless sooner terminated, the
Stock-Based Incentive Plan will be in effect for a period of ten years from the
earlier of adoption by the Security Financial board of directors or approval by
Security Financial stockholders. If the stockholders approve the Plan, Security
Financial intends to grant Stock Options under the plan at an exercise price
equal to at least the fair market value of the underlying common stock on the
date of grant.
An individual will not be deemed to have received taxable income upon the
grant or exercise of any Incentive Stock Option, provided that such shares
received through the exercise of such option are not disposed of by the employee
for at least one year after the date the stock is received in connection with
the stock option exercise and two years after the date of grant of the stock
option (a "disqualifying disposition"). No compensation deduction will be
available to Security Financial as a result of the grant or exercise of
Incentive Stock Options unless there has been a disqualifying disposition. In
the case of a Non-Statutory Stock Option and in the case of a disqualifying
disposition of an Incentive Stock Option, an individual will realize ordinary
income upon exercise of the stock option (or upon the disqualifying disposition)
in an amount equal to the amount by which the fair market value of the common
stock purchased by exercising the stock option on the date of exercise exceeds
the exercise price. The amount of any ordinary income realized by an optionee
upon the exercise of a Non-Statutory Stock Option or due to a disqualifying
disposition of an Incentive Stock Option will be a deductible expense to
Security Financial for income tax purposes.
The Stock-Based Incentive Plan will provide for the granting of Stock
Awards. Grants of Stock Awards to officers and employees may be made in the form
of base grants and/or performance grants (the vesting of which would be
contingent upon performance goals established by the committee administering the
plan). In establishing any performance goals, the committee may utilize the
annual financial results of Security Federal, actual performance of Security
Federal as compared to targeted goals such as the ratio of Security Federal's
net worth to total assets, Security Federal's return on average assets, or such
other performance standards as determined by the committee with the approval of
the Security Financial board of directors.
When a participant becomes vested with respect to Stock Awards, the
participant will realize ordinary income equal to the fair market value of the
common stock at the time of vesting (unless the participant made an election
under Section 83(b) of the Internal Revenue Code). The amount of income
recognized by the participants will be a deductible expense for tax purposes for
Security Financial. When restricted Stock Awards become vested and shares of
common stock are actually distributed to participants, the participants would
receive amounts equal to any accrued dividends with respect thereto. Before
vesting, recipients of Stock Awards may direct the voting of the shares awarded
to them. Shares not subject to grants and shares allocated subject to the
achievement of performance goals will be voted by the trustee in proportion to
the directions provided with respect to shares subject to grants. Vested shares
will be distributed to recipients as soon as practicable following the day on
which they vest.
The vesting periods for awards under the Stock-Based Incentive Plan will be
determined by the committee administering the plan. If the Stock-Based Incentive
Plan is adopted within one year after conversion, awards would become vested and
exercisable within the limits of applicable regulations, which such regulations
require that any awards begin vesting no earlier than one year from the date of
shareholder approval of the plan and, thereafter, vest at
72
a rate of no more than 20% per year and may not be accelerated except in the
case of death or disability. Stock Options could be exercisable for three months
following the date on which the employee or director ceases to perform services
for Security Federal or Security Financial, except that if an employee or
director dies or becomes disabled, Stock Options accelerate and become fully
vested and could be exercisable for up to one year thereafter or such longer
period as determined by Security Financial. In the case of death or disability,
Stock Options may be exercised for a period of 12 months. However, any Incentive
Stock Options exercised more than three months following the date the employee
ceases to perform services as an employee would be treated as a Non-Statutory
Stock Option. If the optionee continues to perform services as a director or
consultant on behalf of Security Federal, Security Financial or an affiliate
after retirement, unvested Stock Options would continue to vest in accordance
with their original vesting schedule until the optionee ceases to serve as a
consultant or director. If a participant dies, is disabled or retires, Security
Financial, if requested by the optionee, or the optionee's beneficiary, could
elect, in exchange for vested options, to pay the optionee, or the optionee's
beneficiary if the optionee dies, the amount by which the fair market value of
the common stock exceeds the exercise price of the Stock Options on the date of
the employee's termination of employment.
Within the limits of any applicable regulatory requirements, the Stock-
Based Incentive Plan may be amended after the one-year period ends to provide
for accelerated vesting of previously granted Stock Options or Stock Awards if a
change in control of Security Financial or Security Federal occurs. A change in
control would generally be considered to occur when a person or group of persons
acting in concert acquires beneficial ownership of 20% or more of any class of
equity security of Security Financial or Security Federal or if a tender or
exchange offer, merger or other form of business combination, sale of all or
substantially all of the assets of Security Financial or Security Federal or a
contested election of directors which resulted in the replacement of a majority
of the Security Financial board of directors by persons not nominated by the
directors in office before the contested election occurs.
Transactions with Security Federal
Federal regulations require that all loans or extensions of credit to
executive officers and directors must generally be made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other persons, unless the loan or
extension of credit is made under a benefit program generally available to all
other employees and does not give preference to any insider over any other
employee, must not involve more than the normal risk of repayment or present
other unfavorable features. Security Federal currently does make new loans and
extensions of credit to Security Federal's executive officers, directors and
employees at different rates or terms than those offered to the general public;
however, Security Federal does not give preference to any director or officer
over any other employee, and such loans do not involve more than the normal risk
of repayment or present other unfavorable features. In addition, loans made to a
director or executive officer in an amount that, when aggregated with the amount
of all other loans to the person and his or her related interests, are in excess
of the greater of $1.0 million or 5% of Security Federal's capital and surplus,
up to a maximum of $3.0 million, must be approved in advance by a majority of
the disinterested members of the Board of Directors. See "Regulation and
Supervision--Federal Savings Institution Regulation--Transactions with Related
Parties." The aggregate amount of loans by Security Federal to its executive
officers and directors was $901,000 at June 30, 1999, or approximately 2.5% of
pro forma stockholders' equity assuming that 2,127,500 shares are issued in the
conversion. These loans were performing according to their original terms at
June 30, 1999.
Other Transactions With Affiliates
Dr. Ferrini is the trustee to the Peter Ferrini Declaration Trust which has
a 50% equity interest in Lowell W and F Venture, LLC, an Indiana limited
liability company, which owns Security Federal's Lowell branch office at 2090 E.
Commercial Avenue, Lowell, Indiana. For the fiscal year ended June 30, 1999,
Security Federal paid $67,105 in rental payments to Lowell W and F Venture,
which amount was less than 5% of Security Federal's gross revenues for the
fiscal year ended June 30, 1999 and was greater than 5% of Lowell W and F
Venture's consolidated gross revenues for the fiscal year ended June 30, 1999.
73
Indemnification for Directors and Officers
Security Financial's Certificate of Incorporation contains provisions which
limit the liability of and indemnity of its directors and officers. These
provisions provide that directors and officers will be indemnified and held
harmless by Security Financial when that individual is made a party to civil,
criminal, administrative and investigative proceedings. Directors and officers
will be indemnified to the fullest extent authorized by the Delaware General
Corporation Law against all expense, liability and loss reasonably incurred.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of Security
Financial pursuant to the Certificate of Incorporation or otherwise, Security
Financial has been advised that in the opinion of the SEC, such indemnification
is against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, Security Financial will be required
by federal law to file reports with, and otherwise comply with, the rules and
regulations of the Office of Thrift Supervision. Security Federal is regulated,
examined and supervised extensively by the Office of Thrift Supervision, as its
primary federal regulator, and the Federal Deposit Insurance Corporation, as the
deposit insurer. Security Federal is a member of the Federal Home Loan Bank
System and its deposit accounts are insured up to applicable limits by the
Savings Association Insurance Fund managed by the Federal Deposit Insurance
Corporation. Security Federal must file reports with the Office of Thrift
Supervision and the Federal Deposit Insurance Corporation concerning its
activities and financial condition in addition to obtaining certain approvals
before entering into certain transactions such as mergers with, or acquisitions
of, other savings institutions. The Office of Thrift Supervision and the Federal
Deposit Insurance Corporation examine Security Federal periodically to test
Security Federal's safety and soundness and compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework for Security Federal's activities and is intended primarily to protect
the insurance fund and Security Federal's depositors.
The regulatory structure also gives regulatory authorities extensive
discretion in their supervisory and enforcement activities and examination
policies, including policies regarding asset classification and the
establishment of adequate loan loss reserves for regulatory purposes. Any change
in regulatory requirements and policies, whether by the Office of Thrift
Supervision, the Federal Deposit Insurance Corporation or the Congress, could
have a material adverse impact on Security Financial, Security Federal and their
operations. The description of statutory provisions and regulations that apply
to Security Financial and Security Federal discussed below and elsewhere in this
prospectus is not a complete description of them and their effects on Security
Federal and Security Financial.
Holding Company Regulation
Security Financial will be a unitary savings and loan holding company under
federal law because Security Federal will be its only insured subsidiary
immediately after the conversion. Formerly, a unitary savings and loan holding
company was not restricted as to the types of business activities in which it
could engage, provided that its subsidiary savings association continued to be a
qualified thrift lender. See "--Federal Savings Institution Regulation --
Qualified Thrift Lender Test." Recent legislation, however, restricts unitary
savings and loan holding companies not existing or applied for before May 4,
1999 to activities permissible for a financial holding company as defined under
the legislation, including insurance and securities activities, and those
permitted for a multiple savings and loan holding company as described below.
Security Financial will not qualify for the grandfather and will be limited to
such activities. If Security Financial acquires another savings institution or
savings bank that is not a problem institution, that meets the qualified thrift
lender test and that the Office of Thrift Supervision considers to be a savings
institution, Security Financial would become a multiple savings and loan holding
company if the acquired institution is held as a separate subsidiary and not
merged into Security Federal. As a multiple savings and loan holding company,
Security
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Financial would generally be limited to activities permissible for bank holding
companies under federal law so long as the Office of Thrift Supervision first
approves of these activities, and to certain other activities authorized by
Office of Thrift Supervision regulation.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company and from acquiring or retaining
control of a depository institution that is not insured by the Federal Deposit
Insurance Corporation, unless it first receives the approval of the Office of
Thrift Supervision. In evaluating applications by holding companies to acquire
savings institutions, the Office of Thrift Supervision considers the financial
and managerial resources and future prospects of the holding company and the
institution involved, the effect of the acquisition on the risk to the deposit
insurance funds, the convenience and needs of the community and competitive
factors.
The Office of Thrift Supervision may not approve any acquisition that
results in a multiple savings and loan holding company controlling savings
institutions in more than one state. However, there are two exceptions to this
general rule. First, the approval of interstate supervisory acquisitions by
savings and loan holding companies. Second, the acquisition of a savings
institution in another state if the laws of the state of the target savings
institution specifically permit the acquisition. The states vary in the extent
to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies do not have specific capital
requirements or specific restrictions on the payment of dividends or other
capital distributions, federal regulations place these restrictions on
subsidiary savings institutions as described below. Security Federal must notify
the Office of Thrift Supervision 30 days before declaring any dividend to
Security Financial. In addition, the financial impact of a holding company on
its subsidiary institution is a matter that is evaluated by the Office of Thrift
Supervision, which has authority to order the stoppage of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are
governed by federal law and regulations. These laws and regulations delineate
the nature and extent of the activities in which federal associations may
engage. In particular, many types of lending authority for federal association
are limited to a specified percentage of the institution's capital or assets.
Capital Requirements. The Office of Thrift Supervision capital regulations
require savings institutions to meet three minimum capital standards: a 1.5%
tangible capital ratio, a 3% leverage ratio and an 8% risk-based capital ratio.
Effective April 1, 1999, however, the minimum leverage ratio increased to 4% for
all institutions except those with the highest rating on the CAMELS financial
institution rating system. In addition, the prompt corrective action standards
discussed below also establish, in effect, a minimum 2% tangible capital
standard, a 4% leverage ratio (3% for institutions receiving the highest rating
on the CAMELS financial institution rating system) and, together with the risk-
based capital standard itself, a 4% Tier 1 risk-based capital standard. The
Office of Thrift Supervision regulations also require that, in meeting the
tangible, leverage and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank.
The risk-based capital standard requires an institution to maintain Tier 1
or core capital to risk-weighted assets of at least 4% and total capital to
risk-weighted assets of at least 8%. Total capital is defined as core capital
and supplementary capital. In determining the amount of risk-weighted assets,
all assets, including certain off-balance sheet assets, are multiplied by a
risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision
capital regulation based on the risks believed inherent in the type of asset.
Core or Tier 1 capital is defined as common stockholders' equity and retained
earnings, certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries, less
intangibles other than certain mortgage servicing rights and credit card
relationships. The components of supplementary capital include cumulative
preferred stock, long-term perpetual preferred stock, mandatory convertible
securities, subordinated debt and intermediate preferred
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stock, and the allowance for loan and lease losses limited to a maximum of 1.25%
of risk-weighted assets. Overall, the amount of supplementary capital included
as part of total capital cannot exceed 100% of core capital.
The capital regulations also incorporate an interest rate risk component.
Savings institutions with "above normal" interest rate risk exposure are subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. Presently, the Office of Thrift Supervision has deferred
implementation of the interest rate risk component. At June 30, 1999, Security
Federal met each of its capital requirements. See "Historical and Pro Forma
Regulatory Capital Compliance" for information regarding Security Federal's
compliance with the Office of Thrift Supervision's regulatory capital
requirements.
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a ratio of total
capital to risk weighted assets of less than 8%, a ratio of Tier 1 or core
capital to risk-weighted assets of less than 4%, or a ratio of core capital to
total assets of less than 4%, or 3% or less for institutions with the highest
examination rating, is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized." Although there is a narrow exception, the Office
of Thrift Supervision is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized" if the institution is
critically undercapitalized on average during the calendar quarter 270 days
after becoming critically undercapitalized. The regulation also provides that an
institution must file a capital restoration plan with the Office of Thrift
Supervision within 45 days of the date that the Office of Thrift Supervision
notifies it that it is "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized." Compliance with the plan must be guaranteed by
any parent holding company. In addition, numerous mandatory supervisory actions
immediately apply to an undercapitalized institution, including, but not limited
to, increased monitoring by regulators and restrictions on growth, capital
distributions and expansion. The Office of Thrift Supervision could also take
any one of a number of discretionary supervisory actions, including issuing a
capital directive and replacing senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of Security Federal are presently
insured by the Savings Association Insurance Fund. The Federal Deposit Insurance
Corporation maintains a risk-based assessment system by which institutions are
assigned to one of three categories based on their capitalization and one of
three subcategories based on examination ratings and other supervisory
information. An institution's assessment rate depends upon the categories to
which it is assigned. Assessment rates for Savings Association Insurance Fund
member institutions are determined semiannually by the Federal Deposit Insurance
Corporation and currently range from zero basis points for the healthiest
institutions to 27 basis points for the riskiest.
In addition to the assessment for deposit insurance, institutions are
required to pay on bonds issued in the late 1980s by the Financing Corporation
to recapitalize the predecessor to the Savings Association Insurance Fund.
During 1998, Financing Corporation payments for Savings Association Insurance
Fund members approximated 6.10 basis points, while Bank Insurance Fund members
paid 1.22 basis points. By law, there will be equal sharing of Financing
Corporation payments between the members of both insurance funds on the earlier
of January 1, 2000 or the date the two insurance funds are merged.
Security Federal's assessment rate for fiscal 1999 ranged from 0 to 10
basis points and the premium paid for this period was $102,820. Payments toward
the Financing Corporation bonds amounted to $122,825. The Federal Deposit
Insurance Corporation has authority to increase insurance assessments. A
significant increase in Savings Association Insurance Fund insurance premiums
would likely have an adverse effect on the operating expenses and results of
operations of Security Federal. Management cannot predict what insurance
assessment rates will be in the future.
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The Federal Deposit Insurance Corporation may terminate an institution's
deposit insurance if it finds that the institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition imposed
by the Federal Deposit Insurance Corporation or the Office of Thrift
Supervision. The management of Security Federal does not know of any practice,
condition or violation that might lead to termination of its deposit insurance.
Thrift Rechartering Legislation. Legislation enacted in 1996 provided that
the Bank Insurance Fund and the Savings Association Insurance Fund were to have
merged on January 1, 1999 if there were no more savings associations as of that
date. Various proposals to eliminate the federal savings association charter,
create a uniform financial institutions charter, abolish the Office of Thrift
Supervision and restrict savings and loan holding company activities have been
introduced in Congress. Recent legislation has limited the powers in which
unitary savings and loan holding companies may engage. See "Risk Factors--
Banking reform legislation affects the activities in which Security Financial
may engage." Security Financial is unable to predict whether any other
legislation will be enacted or the extent to which it may affect its powers or
operations.
Loans to One Borrower. Federal law provides that savings institutions must
generally follow the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. See
"Business of Security Federal--Lending Activities--Loans to One Borrower" for
further information.
Qualified Thrift Lender Test. Federal law requires savings institutions to
meet a qualified thrift lender test. Under the test, a savings association is
required to either qualify as a "domestic building and loan association" under
the Internal Revenue Code or maintain at least 65% of its "portfolio assets" in
certain "qualified thrift investments" in at least 9 months out of each 12 month
period. "Portfolio assets" equals total assets less specified liquid assets up
to 20% of total assets, intangibles, including goodwill, and the value of
property used to conduct business. "Qualified thrift investments" are primarily
residential mortgages and related investments, including certain mortgage-backed
securities.
A savings institution that fails the qualified thrift lender test faces
certain operating restrictions and may be required to convert to a commercial
bank charter. As of June 30, 1999, Security Federal complied with the qualified
thrift lender test. Recent legislation has expanded the extent to which
education loans, credit card loans and small business loans may be considered
"qualified thrift investments."
Limitation on Capital Distributions. Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares and
payments to shareholders of another institution in a cash-out merger. The rule
effective through the first quarter of 1999 established three tiers of
institutions based primarily on an institution's capital level. A Tier I
institution exceeded all capital requirements before and after a proposed
capital distribution and has not been advised by the Office of Thrift
Supervision that it needs more than normal supervision. A Tier I institution
could, after first giving notice to but without obtaining approval of the Office
of Thrift Supervision, make capital distributions during the calendar year equal
to the greater of 100% of its net earnings to date during the calendar year plus
the amount that would have reduced by one-half the excess capital over its
capital requirements at the beginning of the calendar year, or 75% of its net
income for the previous four quarters. Any additional capital distributions
required prior regulatory approval.
Effective April 1, 1999, the Office of Thrift Supervision's capital
distribution regulation changed. Under the new regulation, an application to and
the prior approval of the Office of Thrift Supervision is required before any
capital distribution if the institution does not meet the criteria for
"expedited treatment" of applications under Office of Thrift Supervision
regulations (generally, compliance with all capital requirements and examination
ratings in one of two top categories), the total capital distributions for the
calendar year exceed net income for that year plus the amount of retained net
income for the preceding two years, the institution would be undercapitalized
following the distribution or the distribution would otherwise be contrary to a
statute, regulation or agreement with Office of Thrift Supervision. If an
application is not required, the institution must still give advance notice to
Office of Thrift Supervision of the capital distribution. If Security Federal's
capital fell below its regulatory requirements or if the Office of Thrift
Supervision
77
notified it that it was in need of more than normal supervision, Security
Federal's ability to make capital distributions could be restricted. In
addition, the Office of Thrift Supervision could prohibit a proposed capital
distribution, which would otherwise be permitted by the regulation if the Office
of Thrift Supervision determines that the distribution would be an unsafe or
unsound practice.
Liquidity. Security Federal is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than a
specified percentage of its net withdrawable deposit accounts plus short-term
borrowings. This liquidity requirement is currently 4%, but may be changed from
time to time by the Office of Thrift Supervision to any amount within the range
of 4% to 10%. Monetary penalties may be imposed for failure to meet these
liquidity requirements. The Bank met these requirements at June 30, 1999. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for further information.
Assessments. Savings institutions are required to pay assessments to the
Office of Thrift Supervision to fund the agency's operations. The general
assessments, paid on a semi-annual basis, are computed upon the savings
institution's total assets, including consolidated subsidiaries, as reported in
Security Federal's latest quarterly thrift financial report. Security Federal's
assessments for the fiscal year ended June 30, 1999 totaled $82,000.
Branching. Office of Thrift Supervision regulations permit federally
chartered savings associations to branch nationwide under certain conditions.
Generally, federal savings associations may establish interstate networks and
geographically diversify their loan portfolios and lines of business. The Office
of Thrift Supervision authority preempts any state law purporting to regulate
branching by federal savings associations.
Transactions with Related Parties. Security Federal's authority to engage
in transactions with "affiliates" is limited by federal law. Generally, an
affiliate is any company that controls or is under common control with an
institution, including Security Financial. The aggregate amount of covered
transactions with any individual affiliate is limited to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to 20% of the savings institution's capital and
surplus. Certain transactions with affiliates are required to be secured by
collateral in an amount and of a type described in federal law. The purchase of
low quality assets from affiliates is generally prohibited. The transactions
with affiliates must be on terms and under circumstances, that are at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.
Security Federal's authority to extend credit to executive officers,
directors and 10% shareholders, as well as entities within the control of these
persons, is also governed by federal law. These persons are often referred to as
"insiders" of a company. Loans to insiders are required to be made on terms
substantially the same as those offered to unaffiliated individuals and may not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans Security Federal may make to insiders based, in
part, on Security Federal's capital position and requires certain board approval
procedures to be followed.
Enforcement. The Office of Thrift Supervision has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order, to removal of officers and/or
directors, to institution of a receivership or conservatorship, or to
termination of deposit insurance. Civil penalties cover a wide range of
violations and can amount to $25,000 per day, or even $1 million per day in
especially serious cases. The Federal Deposit Insurance Corporation has the
authority to recommend to the Director of the Office of Thrift Supervision that
enforcement action to be taken with respect to a particular savings institution.
If action is not taken by the Director, the Federal Deposit Insurance
78
Corporation has authority to take action under certain circumstances. Federal
law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness.
The guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the Office of Thrift
Supervision determines that a savings institution fails to meet any standard
prescribed by the guidelines, the Office of Thrift Supervision may require the
institution to submit an acceptable plan to achieve compliance with the
standard.
Federal Home Loan Bank System
Security Federal is a member of the Federal Home Loan Bank System, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. Security
Federal, as a member of the Federal Home Loan Bank, is required to acquire and
hold shares of capital stock in that Federal Home Loan Bank in an amount at
least equal to 1.0% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank, whichever is greater.
Security Federal was in compliance with this requirement with an investment in
Federal Home Loan Bank stock at June 30, 1999, of $5.3 million. Federal Home
Loan Bank advances must be secured by specified types of collateral.
The Federal Home Loan Banks are required to provide funds for the
resolution of insolvent thrifts in the late 1980s and to contribute funds for
affordable housing programs. These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
Federal Home Loan Bank advances increased, Security Federal's net interest
income would likely also be reduced. Recent legislation has changed the
structure of the Federal Home Loan Banks funding obligations for insolvent
thrifts, revised the capital structure of the Federal Home Loan Banks and
implemented entirely voluntary membership for Federal Home Loan Banks.
Management cannot predict the effect that these changes may have with respect to
its Federal Home Loan Bank membership.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts,
primarily NOW and regular checking accounts. The regulations generally require
that reserves be maintained against aggregate transaction accounts as follows:
for accounts aggregating $46.5 million or less, subject to adjustment by the
Federal Reserve Board the reserve requirement is 3%; and for accounts
aggregating greater than $46.5 million, the reserve requirement is $1.395
million plus 10%, subject to adjustment by the Federal Reserve Board between 8%
and 14%, against that portion of total transaction accounts in excess of $46.5
million. The first $4.9 million of otherwise reservable balances, as adjusted
by the Federal Reserve Board, are exempted from the reserve requirements.
Security Federal complies with the foregoing requirements.
Community Reinvestment Act
Under the Community Reinvestment Act, as implemented by Office of Thrift
Supervision regulations, a savings association has a continuing and affirmative
obligation consistent with its safe and sound operation to help meet the credit
needs of its entire community, including low and moderate income neighborhoods.
The Community Reinvestment Act does not establish specific lending requirements
or programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the Community
Reinvestment Act. The Community Reinvestment Act requires the Office of Thrift
Supervision, in connection with its examination of an institution, to assess the
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of applications by such institution.
The Community Reinvestment Act requires public disclosure of an institution's
Community Reinvestment
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Act rating. Security Federal's latest Community Reinvestment Act rating,
received from the Office of Thrift Supervision was "Satisfactory."
Federal Securities Laws
Security Financial has filed with the Securities and Exchange Commission a
registration statement under the Securities Act for the registration of the
common stock to be issued in the conversion. Upon completion of the conversion,
Security Financial's common stock will be registered with the Securities and
Exchange Commission under the Exchange Act. Security Financial will then have
to observe the information, proxy solicitation, insider trading restrictions and
other requirements under the Exchange Act.
The registration under the Securities Act of shares of the common stock to
be issued in the conversion does not cover the resale of such shares. Shares of
the common stock purchased by persons who are not affiliates of Security
Financial may be resold without registration. The resale restrictions of Rule
144 under the Securities Act govern shares purchased by an affiliate of Security
Financial. If Security Financial meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of Security
Financial who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of other persons)
would be able to sell in the public market, without registration, a number of
shares not to exceed, in any three-month period, the greater of (1) 1% of the
outstanding shares of Security Financial or (2) the average weekly volume of
trading in such shares during the preceding four calendar weeks. Provision may
be made in the future by Security Financial to permit affiliates to have their
shares registered for sale under the Securities Act under specific
circumstances.
FEDERAL AND STATE TAXATION
Federal Taxation
General. Security Financial and Security Federal intend to report their
income on a fiscal year, consolidated basis using the accrual method of
accounting. The federal income tax laws apply to Security Financial and
Security Federal in the same manner as to other corporations with some
exceptions, including particularly Security Federal's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to Security Federal or Security Financial. Security Federal's federal
tax returns have been either audited or closed under the statute of limitations
through tax year 1994.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for
nonqualifying loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts for tax years beginning after 1995 and require savings
institutions to recapture or take into income certain portions of their
accumulated bad debt reserves. Thrift institutions eligible to be treated as
"small banks," those with assets of $500 million or less, are allowed to use the
experience method that applies to "small banks," while thrift institutions that
are treated as large banks, those with assets exceeding $500 million, are
required to use only the specific charge-off method. As a result, the percentage
of taxable income method of accounting for bad debts is no longer available for
any financial institution.
A thrift institution required to change its method of computing reserves
for bad debts will treat the change as a change in method of accounting,
initiated by the taxpayer, and having been made with the consent of the Internal
Revenue Service. Any adjustment required to be taken into income with respect
to a change in accounting method
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generally will be taken into income ratably over a six-taxable year period,
beginning with the first taxable year beginning after 1995, subject to a 2-year
suspension if the "residential loan requirement" is satisfied. Under the
residential loan requirement provision, the recapture required by the new
legislation will be suspended for each of two successive taxable years,
beginning with Security Federal's 1996 taxable year, in which Security Federal
originates a minimum of certain residential loans based upon the average of the
principal amounts of these loans that Security Federal makes during its six
taxable years preceding its current taxable year.
Security Federal is required to recapture or take into income over a six
year period the excess of the balance of its tax bad debt reserves as of June
30, 1996 over the balance of the reserves as of June 30, 1998. As a result,
Security Federal will incur an additional tax liability of approximately
$438,000, which is being taken into expense beginning in 1998 over a six year
period.
Distributions. If Security Federal makes "non-dividend distributions" to
Security Financial, they will be considered to have been made from Security
Federal's unrecaptured tax bad debt reserves, including the balance of its
reserves as of June 30, 1998, to the extent of the "nondividend distributions,"
and then from Security Federal's supplemental reserve for losses on loans, to
the extent of those reserves, and an amount based on the amount distributed, but
not more than the amount of those reserves, will be included in Security
Federal's income. Non-dividend distributions include distributions in excess of
Security Federal's current and accumulated earnings and profits, as calculated
for federal income tax purposes, distributions in redemption of stock, and
distributions in partial or complete liquidation. Dividends paid out of
Security Federal's current or accumulated earnings and profits will not be so
included in Security Federal's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Therefore, if Security Federal makes a non-dividend
distribution to Security Financial, approximately one and one-half times the
amount of the distribution not in excess of the amount of the reserves would be
includable in income for federal income tax purposes, assuming a 34% federal
corporate income tax rate. Security Federal does not intend to pay dividends
that would result in a recapture of any portion of its bad debt reserves.
Savings Association Insurance Fund Recapitalization Assessment. Federal
legislation enacted in 1996 levied a 65.7 cent fee on every $100 of thrift
deposits held on March 31, 1995. For financial statement purposes, this
assessment was reported as an expense for the quarter ended September 30, 1996.
The law includes a provision which states that the amount of any special
assessment paid to capitalize Savings Association Insurance Fund under this
legislation is deductible in the year of payment.
State Taxation
Indiana imposes an 8.5% franchise tax based on a financial institution's
adjusted gross income as defined by statute. In computing adjusted gross
income, deductions for municipal interest, the bad debt deduction computed using
the reserve method and pre-1990 net operating losses are disallowed. Security
Federal's state franchise tax returns have not been audited for the past five
tax years.
Utilization of Operating Loss Carryforwards
Security Federal has generated operating losses, a portion of which were
used to offset and recoup tax liabilities from prior periods as allowed by the
Internal Revenue Code. The amount of operating losses which were not used are
being carried forward and will be used to offset future tax liabilities until
these deductions are exhausted. Security Federal has operating loss
carryforwards for federal income tax purposes totalling $1.2 million and
operating loss carryforwards for Indiana income tax purposes totalling $2.5
million. These carryforwards expire in 2012 and 2013, and management
anticipates that these carryforwards will be fully utilized during fiscal 2001.
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THE CONVERSION
The Office of Thrift Supervision has approved the plan of conversion,
provided that it is approved by the members of Security Federal and that
Security Financial and Security Federal satisfy certain other conditions imposed
by the Office of Thrift Supervision in its approval. Office of Thrift
Supervision approval is not a recommendation or endorsement of the plan of
conversion.
General
The Board of Directors of Security Federal adopted the plan of conversion
on September 9, 1999, which was amended by the Board of Directors on September
17, 1999, under which Security Federal will be converted from a federally
chartered mutual savings bank to a federally chartered stock savings bank to be
held as a wholly owned subsidiary of Security Financial, a newly formed Delaware
corporation. The following discussion of the plan of conversion contains all
material terms about the conversion. Nevertheless, readers are urged to read
carefully the plan of conversion, which accompanies Security Federal's proxy
statement and is available to members of Security Federal upon request. The plan
of conversion is also filed as an exhibit to the registration statement that
Security Financial has filed with the Securities and Exchange Commission. See
"Where You Can Find More Information." The Office of Thrift Supervision has
approved the plan of conversion with the condition that it is approved by the
members of Security Federal entitled to vote on the matter at a special meeting
on December 27, 1999 and conditioned on the satisfaction of certain other
conditions imposed by the Office of Thrift Supervision in its approval.
The conversion will be accomplished through adoption of a Federal Stock
Charter and Bylaws to authorize the issuance of capital stock by Security
Federal. As part of the conversion, Security Federal will issue all of its newly
issued capital stock, or 1,000 shares of common stock, to Security Financial in
exchange for 50% of the net proceeds from the sale of common stock by Security
Financial.
The plan of conversion provides generally that:
. Security Federal will convert from a federally chartered mutual savings
bank to a federally chartered stock savings bank;
. Security Financial will offer its common stock in the subscription
offering to persons having subscription rights;
. if necessary, shares of common stock not subscribed for in the
subscription offering will be offered in a direct community offering
to certain members of the general public, with preference given to
natural persons and their trusts residing in Lake and Porter Counties,
Indiana, and then to certain members of the general public in a
syndicated community offering through a syndicate of registered
broker-dealers under selected dealers agreements; and
. Security Financial will purchase all of the capital stock of Security
Federal to be issued in the conversion.
As part of the conversion, Security Financial is making a subscription
offering of its common stock to holders of subscription rights in the following
order of priority. First, depositors of Security Federal with $50.00 or more on
deposit as of June 30, 1998. Second, Security Federal's employee stock
ownership plan. Third, depositors of Security Federal with $50.00 or more on
deposit as of September 30, 1999. Finally, depositors of Security Federal as of
October 31, 1999 and borrowers of Security Federal with loans outstanding as of
August 14, 1990 which continue to be outstanding as of October 31, 1999.
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Shares of common stock not subscribed for in the subscription offering may
be offered for sale in the direct community offering. The direct community
offering, if one is held, is expected to begin immediately after the expiration
of the subscription offering, but may begin at any time during the subscription
offering. Shares of common stock not sold in the subscription and direct
community offerings may be offered in the syndicated community offering.
Regulations require that the direct community and syndicated community offerings
be completed within 45 days after completion of the fully extended subscription
offering unless extended by Security Federal or Security Financial with the
approval of the regulatory authorities. If the syndicated community offering is
not feasible, the Board of Directors of Security Federal will consult with the
regulatory authorities to determine an appropriate alternative method for
selling the unsubscribed shares of common stock. The plan of conversion provides
that the conversion must be completed within 24 months after the date of the
approval of the plan of conversion by the members of Security Federal.
No sales of common stock may be completed, either in the subscription
offering, direct community offering or syndicated community offering unless the
plan of conversion is approved by the members of Security Federal.
The completion of the offering, however, depends on market conditions and
other factors beyond Security Federal's control. No assurance can be given as to
the length of time after approval of the plan of conversion at the special
meeting that will be required to complete the Direct Community or syndicated
community offerings or other sale of the common stock. If delays are
experienced, significant changes may occur in the estimated pro forma market
value of Security Financial and Security Federal as converted, together with
corresponding changes in the net proceeds realized by Security Financial from
the sale of the common stock. If the conversion is terminated, Security Federal
would be required to charge all conversion expenses against current income.
Orders for shares of common stock will not be filled until at least
1,572,500 shares of common stock have been subscribed for or sold and the Office
of Thrift Supervision approves the final valuation and the conversion closes. If
the conversion is not completed within 45 days after the last day of the fully
extended subscription offering and the Office of Thrift Supervision consents to
an extension of time to complete the conversion, those who subscribed in the
offerings will be given the right to increase, decrease or rescind their
subscriptions. Unless an affirmative indication is received from subscribers
that they wish to continue to subscribe for shares, the funds will be returned
promptly, together with accrued interest at Security Federal's passbook rate
from the date payment is received until the funds are returned to the
subscriber. If the period is not extended, or, in any event, if the conversion
is not completed, all withdrawal authorizations will be terminated and all funds
held will be promptly returned together with accrued interest at Security
Federal's passbook rate from the date payment is received until the conversion
is terminated.
Reasons for the Conversion
The Board of Directors and management believe that the conversion is in the
best interests of Security Federal, its members and the communities it serves.
Security Federal's Board of Directors has formed Security Financial to serve as
a holding company, with Security Federal as its subsidiary, after the
conversion. By converting to the stock form of organization, Security Financial
and Security Federal will be structured in the form used by holding companies of
commercial banks, most business entities and by a growing number of savings
institutions. Management of Security Federal believes that the conversion offers
a number of advantages that will be important to the future growth and
performance of Security Federal. The capital raised in the conversion is
intended to support Security Federal's current lending and investment activities
and may also support possible future expansion and diversification of
operations, although there are no current specific plans, arrangements or
understandings, written or oral, regarding any expansion or diversification. The
conversion is also expected to afford Security Federal's management, members and
others the opportunity to become stockholders of Security Financial and
participate more directly in, and contribute to, any future growth of Security
Financial and Security Federal. The conversion will also enable Security
Financial and Security Federal to raise additional capital in the public equity
or debt markets should the need arise, although there are no current specific
plans, arrangements or understandings, written or oral, regarding any financing
activities. Security Federal, as a mutual savings bank, does not have the
authority to issue capital stock or debt instruments, other than by accepting
deposits.
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Effects of Conversion to Stock Form
General. Each depositor in a mutual savings bank has both a deposit
account in the institution and a pro rata ownership interest in the net worth of
the institution based upon the balance in his or her account, which interest may
only be realized if the institution is liquidated. However, this ownership
interest is tied to the depositor's account and has no value separate from such
deposit account. Any depositor who opens a deposit account obtains a pro rata
ownership interest in the net worth of the institution without any additional
payment beyond the amount of the deposit. A depositor who reduces or closes his
account receives a portion or all of the balance in the account but nothing for
his ownership interest in the net worth of the institution, which is lost to the
extent that the balance in the account is reduced.
Consequently, mutual savings bank depositors normally realize the value of
their ownership interest only in the unlikely event that the mutual savings bank
is liquidated. In such event, the depositors of record at that time, as owners,
would be able to share in any residual surplus and reserves after other claims,
including claims of depositors to the amounts of their deposits, are paid.
When a mutual savings bank converts to stock form, depositors lose all
rights to the net worth of the mutual savings bank, except the right to claim a
pro rata share of funds representing the liquidation account established in
connection with the conversion. Additionally, permanent nonwithdrawable capital
stock is created and offered to depositors which represents the ownership of the
institution's net worth. The common stock is separate and apart from deposit
accounts and cannot be and is not insured by the Federal Deposit Insurance
Corporation or any other governmental agency. Certificates are issued to
evidence ownership of the permanent stock. The stock certificates are
transferable, and therefore the stock may be sold or traded if a purchaser is
available with no effect on any deposit account the seller may hold in the
institution.
No assets of Security Financial or Security Federal will be distributed in
connection with the conversion other than the payment of those expenses incurred
in connection with the conversion.
Continuity. While the conversion is being accomplished, the normal
business of Security Federal will continue without interruption, including being
regulated by the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation. After conversion, Security Federal will continue to provide
services for depositors and borrowers under current policies by its present
management and staff.
The Directors of Security Federal at the time of conversion will serve as
directors of Security Federal after the conversion. The Directors of Security
Financial will be solely composed of individuals who served on the Board of
Directors of Security Federal. All officers of Security Federal at the time of
conversion will retain their positions after the conversion.
Savings Accounts and Loans. Security Federal's savings accounts, account
balances and existing Federal Deposit Insurance Corporation insurance coverage
of savings accounts will not be affected by the conversion. Furthermore, the
conversion will not affect the loan accounts, loan balances or obligations of
borrowers under their individual contractual arrangements with Security Federal.
Voting Rights. Savings members and borrowers will have no voting rights in
the converted association or Security Financial and therefore will not be able
to elect directors of Security Federal or Security Financial or to control their
affairs. Currently, these rights are accorded to savings members of Security
Federal. After the conversion, voting rights will be vested exclusively in
Security Financial with respect to Security Federal and the holders of the
common stock as to matters pertaining to Security Financial. Each holder of
common stock shall be entitled to vote on any matter to be considered by the
stockholders of Security Financial. A stockholder will be entitled to one vote
for each share of common stock owned.
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Tax Effects. Security Federal has received an opinion from Muldoon, Murphy
& Faucette LLP, Washington, D.C., that addresses all the material federal income
tax consequences of the conversion. The opinion, which relies upon factual
representations given by Security Federal, concludes that the conversion will
constitute a nontaxable reorganization under Section 368(a)(1)(F) of the
Internal Revenue Code of 1986, as amended. Among other things, the opinion
states that:
. No gain or loss will be recognized to Security Federal in its mutual
or stock form by reason of the conversion;
. No gain or loss will be recognized to its account holders upon the
issuance to them of accounts in Security Federal immediately after the
conversion, in the same dollar amounts and on the same terms and
conditions as their accounts at Security Federal in its mutual form
plus interest in the liquidation account;
. The tax basis of account holders' accounts in Security Federal
immediately after the conversion will be the same as the tax basis of
their accounts immediately before conversion;
. The tax basis of each account holder's interest in the liquidation
account will be equal to the value, if any, of that interest;
. The tax basis of the common stock purchased in the conversion will be
the amount paid and the holding period for the stock will begin on the
date of purchase; and
. No gain or loss will be recognized to account holders upon the
receipt or exercise of subscription rights in the conversion, except
if subscription rights are deemed to have value as discussed below.
Unlike a private letter ruling issued by the Internal Revenue Service, an
opinion of counsel is not binding on the Internal Revenue Service and the
Internal Revenue Service could disagree with the conclusions reached in the
opinion. If there is a disagreement, no assurance can be given that the
conclusions reached in an opinion of counsel would be sustained by a court if
contested by the Internal Revenue Service.
Based upon past rulings issued by the Internal Revenue Service, the opinion
provides that the receipt of subscription rights by eligible account holders,
supplemental eligible account holders and other members under the plan of
conversion will be taxable if the subscription rights are deemed to have a fair
market value. Keller & Company, whose findings are not binding on the Internal
Revenue Service, has issued a letter indicating that the subscription rights do
not have any value, based on the fact that the rights are acquired by the
recipients without cost, are nontransferable and of short duration and afford
the recipients the right only to purchase shares of the common stock at a price
equal to its estimated fair market value, which will be the same price paid by
purchasers in the direct community offering for unsubscribed shares of common
stock. If the subscription rights are deemed to have a fair market value, the
receipt of the rights may only be taxable to those persons who exercise their
subscription rights. Security Federal could also recognize a gain on the
distribution of subscription rights. Holders of subscription rights are
encouraged to consult with their own tax advisors as to the tax consequences if
the subscription rights are deemed to have a fair market value.
Security Federal has also received an opinion from Crowe, Chizek and
Company LLP, Oak Brook, Illinois, that, assuming the conversion does not result
in any federal income tax liability to Security Federal, its account holders, or
Security Financial, implementation of the plan of conversion will not result in
any Indiana income tax liability to those entities or persons.
The opinions of Muldoon, Murphy & Faucette LLP and Crowe, Chizek and
Company LLP, and the letter from Keller & Company are filed as exhibits to the
registration statement that Security Financial has filed with the Securities and
Exchange Commission. See "Where You Can Find More Information."
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Prospective investors are urged to consult with their own tax advisors
regarding the tax consequences of the conversion particular to them.
Liquidation Account. In the unlikely event of a complete liquidation of
Security Federal, before the conversion, each depositor in Security Federal
would receive a pro rata share of any assets of Security Federal remaining after
payment of claims of all creditors, including the claims of all depositors up to
the withdrawal value of their accounts. Each depositor's pro rata share of the
remaining assets would be in the same proportion as the value of his or her
deposit account to the total value of all deposit accounts in Security Federal
at the time of liquidation.
After the conversion, holders of withdrawable deposit(s) in Security
Federal, including certificates of deposit, shall not be entitled to share in
any residual assets upon liquidation of Security Federal. However, under Office
of Thrift Supervision regulations, Security Federal shall, at the time of the
conversion, establish a liquidation account in an amount equal to its total
equity as of the date of the latest statement of financial condition contained
in the final prospectus relating to the conversion.
The liquidation account shall be maintained by Security Federal after the
conversion for the benefit of eligible account holders and supplemental eligible
account holders who retain their savings accounts in Security Federal. Each
eligible account holder and supplemental eligible account holder shall, with
respect to each savings account held, have a related inchoate interest in a sub-
account portion of the liquidation account balance.
The initial subaccount balance for a savings account held by an eligible
account holder or a supplemental eligible account holder shall be determined by
multiplying the opening balance in the liquidation account by a fraction of
which the numerator is the amount of the holder's "qualifying deposit" in the
savings account and the denominator is the total amount of the "qualifying
deposits" of all eligible account holders. The initial subaccount balance shall
not be increased, and it shall be decreased as provided below.
If the deposit balance in any savings account of an eligible account holder
or supplemental eligible account holder at the close of business on any annual
closing day of Security Federal after June 30, 1998, or September 30, 1999 is
less than the lesser of the deposit balance in a savings account at the close of
business on any other annual closing date after June 30, 1998 or September 30,
1999, or the amount of the "qualifying deposit" in a savings account on June 30,
1998 or September 30, 1999, then the subaccount balance for a savings account
shall be adjusted by reducing the subaccount balance in an amount proportionate
to the reduction in the deposit balance. Once reduced, the subaccount balance
shall not be subsequently increased, notwithstanding any increase in the deposit
balance of the related savings account. If any savings account is closed, the
related subaccount balance shall be reduced to zero.
Only upon a complete liquidation of Security Federal, each eligible account
holder and supplemental eligible account holder shall be entitled to receive a
liquidation distribution from the liquidation account in the amount of the then
current adjusted subaccount balance(s) for savings account(s) held by the holder
before any liquidation distribution may be made to stockholders. No merger,
consolidation, bulk purchase of assets with assumptions of savings account and
other liabilities or similar transactions with another federally insured
institution in which Security Federal is not the surviving institution shall be
considered to be a complete liquidation. In any of these transaction the
liquidation account shall be assumed by the surviving institution.
In the unlikely event Security Federal is liquidated after the conversion,
depositors will be entitled to full payment of their deposit accounts before any
payment is made to Security Financial as the sole stockholder of Security
Federal.
The Subscription, Direct Community and Syndicated Community Offerings
Subscription Offering. Under the plan of conversion, nontransferable
subscription rights to purchase the common stock have been issued to persons and
entities entitled to purchase the common stock in the subscription offering. The
amount of the common stock which these parties may purchase will depend on the
availability of the
86
common stock for purchase under the categories described in the plan of
conversion. Subscription priorities have been established for the allocation of
stock that may be available. These priorities are as follows:
Category 1: Eligible Account Holders. Each depositor with $50.00 or more
on deposit at Security Federal, including all withdrawable deposits at Security
Federal, including non-interest bearing deposits, as of June 30, 1998 will
receive nontransferable subscription rights to subscribe for up to the greater
of $200,000 of common stock, which equals 20,000 shares, one-tenth of one
percent of the total offering of common stock or 15 times the product, rounded
down to the next whole number, obtained by multiplying the total number of
shares of common stock to be issued by a fraction of which the numerator is the
amount of qualifying deposit of the eligible account holder and the denominator
is the total amount of qualifying deposits of all eligible account holders. If
the exercise of subscription rights in this category results in an
oversubscription, shares of common stock will be allocated among subscribing
eligible account holders so as to permit each one, if possible, to purchase a
number of shares sufficient to make the person's total allocation equal 100
shares or the number of shares actually subscribed for, whichever is less. After
that, unallocated shares will be allocated proportionately, based on the amount
of the eligible accountholder's qualifying deposits as compared to total
qualifying deposits of all subscribing eligible account holders. Subscription
rights received by officers and directors in this category based on any
increased deposits in Security Federal in the one year period preceding June 30,
1998 are subordinated to the subscription rights of other eligible account
holders.
Category 2: Employee Stock Ownership Plan. The plan of conversion provides
that the employee stock ownership plan shall receive nontransferable
subscription rights to purchase up to 8% of the shares of common stock issued in
the conversion. The plan intends to purchase 8% of the shares of common stock
issued in the conversion. If the number of shares offered in the conversion is
increased, the plan shall have a priority right to purchase any shares exceeding
that amount up to 8% of the common stock. If the plan's subscription is not
filled in its entirety, the employee stock ownership plan may purchase shares in
the open market or may purchase shares directly from Security Financial.
Category 3: Supplemental Eligible Account Holders. Each depositor with
$50.00 or more on deposit, including all withdrawable deposits at Security
Federal, including non-interest bearing deposits, as of September 30, 1999 will
receive nontransferable subscription rights to subscribe for up to the greater
of $200,000 of common stock, which equals 20,000 shares, one-tenth of one
percent of the total offering of common stock or 15 times the product, rounded
down to the next whole number, obtained by multiplying the total number of
shares of common stock to be issued by a fraction of which the numerator is the
amount of qualifying deposits of the supplemental eligible account holder and
the denominator is the total amount of qualifying deposits of all supplemental
eligible account holders. If the exercise of subscription rights in this
category results in an oversubscription, shares of common stock will be
allocated among subscribing supplemental eligible account holders so as to
permit each supplemental eligible account holder, if possible, to purchase a
number of shares sufficient to make his or her total allocation equal 100 shares
or the number of shares actually subscribed for, whichever is less. After that,
unallocated shares will be allocated among subscribing supplemental eligible
account holders proportionately, based on the amount of their respective
qualifying deposits as compared to total qualifying deposits of all subscribing
supplemental eligible account holders.
Category 4: Other Members. Each depositor of Security Federal, including
persons with withdrawable deposits at Security Federal, including non-interest
bearing demand deposits, as of October 31, 1999 and each borrower with a loan
outstanding on August 14, 1990 which continues to be outstanding as of October
31, 1999 will receive nontransferable subscription rights to purchase up to
$200,000 of common stock, which equals 20,000 shares, in the conversion if
shares are available following subscriptions by eligible account holders,
Security Federal's employee stock ownership plan and supplemental eligible
account holders. If there is an oversubscription in this category, the available
shares will be allocated proportionately based on the amount of the respective
subscriptions.
Subscription rights are nontransferable. Persons selling or otherwise
transferring their rights to subscribe for common stock in the subscription
offering or subscribing for common stock on behalf of another person may forfeit
those rights and may face possible further sanctions and penalties imposed by
the Office of Thrift Supervision or another agency of the U.S. Government. Each
person exercising subscription rights will be required to certify that he or she
is purchasing shares solely for his or her own account and that he or she has
87
no agreement or understanding with any other person for the sale or transfer of
the shares. Once tendered, subscription orders cannot be revoked without the
consent of Security Federal and Security Financial.
Security Financial and Security Federal will make reasonable attempts to
provide a prospectus and related offering materials to holders of subscription
rights. However, the subscription offering and all subscription rights under the
plan of conversion will expire at 12:00 noon, Central time, on December 15,
1999, whether or not Security Federal has been able to locate each person
entitled to subscription rights. Orders for common stock in the subscription
offering received in hand by Security Federal after that time will not be
accepted. The subscription offering may be extended by Security Financial and
Security Federal up to January 29, 2000 without regulatory approval. Office of
Thrift Supervision regulations require that Security Financial complete the sale
of common stock within 45 days after the close of the subscription offering. If
the direct community offering and the syndicated community offerings are not
completed within that period all funds received will be promptly returned with
interest at Security Federal's passbook rate and all withdrawal authorizations
will be canceled. If regulatory approval of an extension of the time period has
been granted, all subscribers will be notified of the extension and of the
duration of any extension that has been granted, and will be given the right to
increase, decrease or rescind their orders. If an affirmative response to any
resolicitation is not received by Security Financial from a subscriber, the
subscriber's order will be rescinded and all funds received will be promptly
returned with interest, or withdrawal authorizations will be canceled. No single
extension can exceed 90 days.
Direct Community Offering. Any shares of common stock which remain
unsubscribed for in the subscription offering will be offered by Security
Financial to certain members of the general public in a direct community
offering, with preference given to natural persons and trusts of natural persons
residing in Lake and Porter Counties, Indiana. Purchasers in the direct
community offering are eligible to purchase up to $200,000 of common stock,
which equals 20,000 shares. If not enough shares are available to fill orders in
the direct community offering, the available shares will be allocated on a pro
rata basis determined by the amount of the respective orders. The direct
community offering, if held, may be concurrent with, during or promptly after
the subscription offering. The direct community offering may terminate on or at
any time after 12:00 noon, Central time, on December 15, 1999, but no later than
45 days after the close of the subscription offering, unless extended by
Security Financial and Security Federal, with approval of the Office of Thrift
Supervision. If regulatory approval of an extension of the time period has been
granted, all subscribers will be notified of the extension and of the duration
of any extension that has been granted, and will be given the right to increase,
decrease or rescind their orders. If an affirmative response to any
resolicitation is not received by Security Financial from a subscriber, the
subscriber's order will be rescinded and all funds received will be promptly
returned with interest. Security Financial and Security Federal have the
absolute right to accept or reject in whole or in part any orders to purchase
shares in the direct community offering. If an order is rejected in part, the
purchaser does not have the right to cancel the remainder of the order. Security
Financial presently intends to terminate the direct community offering as soon
as it has received orders for all shares available for purchase in the
conversion.
If all of the common stock offered in the subscription offering is
subscribed for, no common stock will be available for purchase in the direct
community offering.
Syndicated Community Offering. The plan of conversion provides that, if
necessary, all shares of common stock not purchased in the subscription offering
and direct community offering, if any, may be offered for sale to certain
members of the general public in a syndicated community offering through a
syndicate of registered broker-dealers to be formed and managed by KBW acting as
agent of Security Financial. Security Financial and Security Federal have the
right to reject orders, in whole or part, in their sole discretion in the
syndicated community offering. Neither KBW nor any registered broker-dealer
shall have any obligation to take or purchase any shares of the common stock in
the syndicated community offering; however, KBW has agreed to use its best
efforts in the sale of shares in the syndicated community offering.
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Stock sold in the syndicated community offering also will be sold at the
$10.00 purchase price. See "--Stock Pricing and Number of Shares to Be Issued."
No person will be permitted to subscribe in the syndicated community offering
for shares of common stock with an aggregate purchase price of more than
$200,000 of common stock, which equals 20,000 shares. See "--Plan of
Distribution for the Subscription, Direct Community and Syndicated Community
Offerings" for a description of the commission to be paid to the selected
dealers and to KBW.
KBW may enter into agreements with selected dealers to assist in the sale
of shares in the syndicated community offering. During the syndicated community
offering, selected dealers may only solicit indications of interest from their
customers to place orders with Security Financial as of a certain date for the
purchase of shares. When and if KBW and Security Financial believe that enough
indications of interest and orders have been received in the subscription
offering, the direct community offering and the syndicated community offering to
consummate the conversion, KBW will request, as of that certain date, selected
dealers to submit orders to purchase shares for which they have received
indications of interest from their customers. Selected dealers will send
confirmations to customers on the next business day after that certain date.
Selected dealers may settle the trade by debiting the accounts of their
customers on a date which will be three business days from that certain date.
Customers who authorize selected dealers to debit their brokerage accounts are
required to have the funds for payment in their account on but not before the
settlement date. On the settlement date, selected dealers will remit funds to
the account that Security Financial established for each selected dealer. Each
customer's funds so forwarded to Security Financial, along with all other
accounts held in the same title, will be insured by the Federal Deposit
Insurance Corporation up to the applicable deposit insurance limit. After
payment has been received by Security Financial from selected dealers, funds
will earn interest at Security Federal's passbook rate until the completion of
the offering. At the completion of the conversion, the funds received will be
used to purchase the shares of common stock ordered. The shares issued in the
conversion cannot and will not be insured by the Federal Deposit Insurance
Corporation or any other government agency. If the conversion is not completed,
funds with interest will be returned promptly to the selected dealers, who, in
turn, will promptly credit their customers' brokerage accounts.
The syndicated community offering may terminate no more than 45 days after
the expiration of the subscription offering, unless extended by Security
Financial and Security Federal, with approval of the Office of Thrift
Supervision.
If Security Federal is unable to find purchasers from the general public
for all unsubscribed shares, other purchase arrangements will be made by the
Board of Directors of Security Federal, if feasible. Any other arrangements
must be approved by the Office of Thrift Supervision. The Office of Thrift
Supervision may grant one or more extensions of the offering period, provided
that no single extension exceeds 90 days, subscribers are given the right to
increase, decrease or rescind their subscriptions during the extension period,
and the extensions do not go more than two years beyond the date on which the
members approved the plan of conversion. If the conversion is not completed
within 45 days after the close of the subscription offering, either all funds
received will be returned with interest, and withdrawal authorizations canceled,
or, if the Office of Thrift Supervision has granted an extension of time, all
subscribers will be given the right to increase, decrease or rescind their
subscriptions at any time before 20 days before the end of the extension period.
If an extension of time is obtained, all subscribers will be notified of the
extension and of their rights to modify their orders. If an affirmative response
to any resolicitation is not received by Security Financial from a subscriber,
the subscriber's order will be rescinded and all funds received will be promptly
returned with interest or withdrawal authorizations will be canceled.
Persons in Non-Qualified States. Security Financial and Security Federal
will make reasonable efforts to comply with the securities laws of all states in
the United States in which persons entitled to subscribe for stock under the
plan of conversion reside. However, Security Financial and Security Federal are
not required to offer stock in the subscription offering to any person who
resides in a foreign country, who resides in a state of the United States in
which only a small number of persons otherwise eligible to subscribe for shares
of common stock reside, or in a state where Security Financial or Security
Federal determines that compliance with that state's securities laws would be
impracticable for reasons of cost or otherwise, including but not limited to a
request or requirement that Security Financial and Security Federal or their
officers, directors or trustees register as a broker, dealer, salesman or
selling agent, under the securities laws of the state, or a request or
requirement to register or otherwise qualify the subscription
89
rights or common stock for sale or submit any filing in the state. Where the
number of persons eligible to subscribe for shares in one state is small,
Security Financial and Security Federal will base their decision as to whether
or not to offer the common stock in the state on a number of factors, including
the size of accounts held by account holders in the state, the cost of reviewing
the registration and qualification requirements of the state, and of actually
registering or qualifying the shares, or the need to register Security
Financial, its officers, directors or employees as brokers, dealers or salesmen.
Plan of Distribution for the Subscription, Direct Community and Syndicated
Community Offerings
Security Federal and Security Financial have retained Webb to consult with
and advise Security Federal and to assist Security Federal and Security
Financial, on a best efforts basis, in the distribution of shares in the
offering. Webb is a broker-dealer registered with the Securities and Exchange
Commission and a member of the National Association of Securities Dealers, Inc.
Webb will assist Security Federal in the conversion by acting as marketing
advisor with respect to the subscription offering and will represent Security
Federal as placement agent on a best efforts basis in the sale of the common
stock in the direct community offering if one is held; conducting training
sessions with directors, officers and employees of Security Federal regarding
the conversion process; and assisting in the establishment and supervision of
Security Federal's stock information center and, with management's input, will
train Security Federal's staff to record properly and tabulate orders for the
purchase of common stock and to respond appropriately to customer inquiries.
Based upon negotiations between Webb and Security Financial and Security
Federal concerning fee structure, Webb will receive a management fee of $25,000
and a success fee of 1.35% of the aggregate purchase price of the shares sold in
the offering, excluding shares purchased by the ESOP and officers, directors and
employees of Security Federal, or members of their immediate families. Webb and
selected dealers participating in the syndicated community offering may receive
a commission in the syndicated community offering of up to a maximum amount of
5.5% of the aggregate purchase price of the shares sold by Webb and the broker-
dealers and Webb will pay to the broker-dealers an amount competitive with gross
underwriting commissions then charged for comparable amounts of stock sold at a
comparable price per share in a similar market environment. In addition,
Security Financial and the Bank have agreed to reimburse Webb for reasonable
out-of-pocket expenses up to $5,000 and for legal fees and expenses up to
$35,000.
With certain limitations, Security Financial and Security Federal have also
agreed to indemnify Webb against liabilities and expenses, including legal fees,
incurred in connection with certain claims or litigation arising out of or based
upon untrue statements or omissions contained in the offering material for the
common stock or with regard to allocations of shares if there is an
oversubscription, or determinations of eligibility to purchase shares.
Description of Sales Activities
The common stock will be offered in the subscription offering and direct
community offering principally by the distribution of this prospectus and
through activities conducted at Security Federal's stock information center at
its main office. The stock information center is expected to operate during
normal business hours throughout the subscription offering and direct community
offering. It is expected that at any particular time one or more Webb employees
will be working at the stock information center. Employees of Webb will be
responsible for mailing materials relating to the offering, responding to
questions regarding the conversion and the offering and processing stock orders.
Sales of common stock will be made by registered representatives affiliated
with Webb or by the selected dealers managed by Webb. The management and
employees of Security Federal may participate in the offering in clerical
capacities, providing administrative support in effecting sales transactions or,
when permitted by state securities laws, answering questions of a mechanical
nature relating to the proper execution of the order form. Management of
Security Federal may answer questions regarding the business of Security Federal
when permitted by state securities laws. Other questions of prospective
purchasers, including questions as to the advisability or nature of the
investment, will be directed to registered representatives. The management and
employees of Security Financial and Security Federal
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have been instructed not to solicit offers to purchase common stock or provide
advice regarding the purchase of common stock.
No officer, director or employee of Security Federal or Security Financial
will be compensated, directly or indirectly, for any activities in connection
with the offer or sale of securities issued in the conversion.
None of Security Federal's personnel assisting in the offering is
registered or licensed as a broker or dealer or an agent of a broker or dealer.
Certain directors and executive officers of Security Federal may assist in the
solicitation of offers to purchase common stock and other Security Federal
personnel may also assist in the above-described sales activities under an
exemption from registration as a broker or dealer provided by Rule 3a4-1
promulgated under the Securities Exchange Act of 1934, as amended. Rule 3a4-1
generally provides that an "associated person of an issuer" of securities shall
not be deemed a broker solely by reason of participation in the sale of
securities of the issuer if the associated person meets certain conditions.
These conditions include, but are not limited to, that the associated person
participating in the sale of an issuer's securities not be compensated in
connection therewith at the time of participation, that the person not be
associated with a broker or dealer and that the person observe certain
limitations on his or her participation in the sale of securities. For purposes
of this exemption, "associated person of an issuer" is defined to include any
person who is a director, officer or employee of the issuer or a company that
controls, is controlled by or is under common control with the issuer.
Procedure for Purchasing Shares in the Subscription and Direct Community
Offerings
To purchase shares in the subscription offering, an executed order form
with the required full payment for each share subscribed for, or with
appropriate authorization indicated on the stock order form for withdrawal of
full payment from the subscriber's deposit account with Security Federal, must
be received by Security Federal by 12:00 noon, Central time, on December 15,
1999. Order forms that are not received by that time or are executed defectively
or are received without full payment or without appropriate withdrawal
instructions are not required to be accepted. Security Financial and Security
Federal have the right to waive or permit the correction of incomplete or
improperly executed order forms, but do not represent that they will do so.
Under the plan of conversion, the interpretation by Security Financial and
Security Federal of the terms and conditions of the plan of conversion and of
the order form will be final. In order to purchase shares in the direct
community offering, the order form, accompanied by the required payment for each
share subscribed for, must be received by Security Federal before the direct
community offering terminates, which may be on or at any time after the end of
the offering. Once received, an executed order form may not be modified, amended
or rescinded without the consent of Security Federal unless the conversion has
not been completed within 45 days after the end of the subscription offering,
unless extended.
In order to ensure that persons with subscription rights are properly
identified as to their stock purchase priorities, they must list all accounts on
the order form giving all names in each account, the account number and the
approximate account balance as of the appropriate eligibility date. Failure to
list an account could result in fewer shares allocated if there is an
oversubscription than if all accounts had been disclosed.
Full payment for subscriptions may be made by check, bank draft or money
order, or by authorization of withdrawal from deposit accounts maintained with
Security Federal. Appropriate means by which withdrawals may be authorized are
provided on the order form. No wire transfers will be accepted. Interest will be
paid on payments made by cash, check, bank draft or money order at Security
Federal's passbook rate from the date payment is received at the stock
information center until the completion or termination of the conversion. If
payment is made by authorization of withdrawal from deposit accounts, the funds
authorized to be withdrawn from a deposit account will continue to accrue
interest at the contractual rates until completion or termination of the
conversion, unless the certificate matures after the date of receipt of the
order form but before closing, in which case funds will earn interest at the
passbook rate from the date of maturity until the conversion is completed or
terminated, but a hold will be placed on the funds, making them unavailable to
the depositor until completion or termination of the conversion. When the
conversion is completed, the funds received in the offering will be used to
purchase the shares of common stock ordered. The shares of common stock issued
in the conversion cannot and will not be insured by the Federal Deposit
Insurance Corporation or
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any other government agency. If the conversion is not consummated for any
reason, all funds submitted will be promptly refunded with interest as described
above.
If a subscriber authorizes Security Federal to withdraw the amount of the
aggregate purchase price from his or her deposit account, Security Federal will
do so as of the effective date of conversion, though the account must contain
the full amount necessary for payment at the time the subscription order is
received. Security Federal will waive any applicable penalties for early
withdrawal from certificate accounts. If the remaining balance in a certificate
account is reduced below the applicable minimum balance requirement at the time
funds are actually transferred under the authorization the certificate will be
canceled at the time of the withdrawal, without penalty, and the remaining
balance will earn interest at Security Federal's passbook rate.
The employee stock ownership plan will not be required to pay for the
shares subscribed for at the time it subscribes, but rather may pay for shares
of common stock subscribed for at the $10.00 purchase price after the
conversion, provided that there is in force from the time of its subscription
until that time, a loan commitment from an unrelated financial institution or
Security Financial to lend to the employee stock ownership plan, at that time,
the aggregate purchase price of the shares for which it subscribed.
Individual retirement accounts maintained in Security Federal do not permit
investment in the common stock. A depositor interested in using his or her
Individual Retirement Account funds to purchase common stock must do so through
a self-directed individual retirement account. Since Security Federal does not
offer those accounts, it will allow a depositor to make a trustee-to-trustee
transfer of the individual retirement account funds to a trustee offering a
self-directed individual retirement account program with the agreement that the
funds will be used to purchase Security Financial's common stock in the
offering. There will be no early withdrawal or Internal Revenue Service interest
penalties for transfers. The new trustee would hold the common stock in a self-
directed account in the same manner as Security Federal now holds the
depositor's Individual Retirement Account funds. An annual administrative fee
may be payable to the new trustee. Depositors interested in using funds in an
individual retirement account at Security Federal to purchase common stock
should contact the stock information center as soon as possible so that the
necessary forms may be forwarded for execution and returned before the
subscription offering ends. In addition, federal laws and regulations require
that officers, directors and 10% shareholders who use self-directed individual
retirement account funds to purchase shares of common stock in the subscription
offering, make purchases for the exclusive benefit of individual retirement
accounts.
Certificates representing shares of common stock purchased, and any refund
due, will be mailed to purchasers at the address specified in properly completed
order forms or to the last address of the persons appearing on the records of
Security Federal as soon as practicable following the sale of all shares of
common stock. Any certificates returned as undeliverable will be disposed of as
required by applicable law. Purchasers may not be able to sell the shares of
common stock which they purchased until certificates for the common stock are
available and delivered to them, even though trading of the common stock may
have begun.
To ensure that each purchaser receives a prospectus at least 48 hours
before the end of the offering as required by Rule 15c2-8 under the Securities
Exchange Act of 1934, as amended, no prospectus will be mailed any later than
five days before that date or hand delivered any later than two days before that
date. Execution of the order form will confirm receipt or delivery under Rule
15c2-8. Order forms will only be distributed with a prospectus. Security Federal
will accept for processing only orders submitted on original order forms.
Security Federal is not obligated to accept orders submitted on photocopied or
telecopied order forms. Orders cannot and will not be accepted without the
execution of the certification appearing on the reverse side of the order form.
Stock Pricing and Number of Shares to be Issued
Federal regulations require that the aggregate purchase price of the
securities sold in connection with the conversion be based upon an estimated pro
forma value of Security Financial and Security Federal as converted, as
determined by an independent appraisal. Security Federal and Security Financial
have retained Keller & Company to
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prepare an appraisal of the pro forma market value of Security Financial and
Security Federal as converted, as well as a business plan. Keller & Company will
receive a fee expected to total approximately $28,000 for its appraisal services
and assistance in the preparation of a business plan, plus reasonable out-of-
pocket expenses incurred in connection with the appraisal. Security Federal has
agreed to indemnify Keller & Company under certain circumstances against
liabilities and expenses, including legal fees, arising out of, related to, or
based upon the conversion.
Keller & Company has prepared an appraisal of the estimated pro forma
market value of Security Financial and Security Federal as converted taking into
account the formation of Security Financial as Security Financial for Security
Federal. For its analysis, Keller & Company undertook substantial investigations
to learn about Security Federal's business and operations. Management supplied
financial information, including annual financial statements, information on the
composition of assets and liabilities, and other financial schedules. In
addition to this information, Keller & Company reviewed Security Federal's
conversion application as filed with the Office of Thrift Supervision and
Security Financial's registration statement as filed with the Securities and
Exchange Commission. Furthermore, Keller & Company visited Security Federal's
facilities and had discussions with Security Federal's management and its
special conversion legal counsel, Muldoon, Murphy & Faucette LLP. Keller &
Company did not perform a detailed individual analysis of the separate
components of Security Financial's or Security Federal's assets and liabilities.
Keller & Company's analysis utilized three selected valuation procedures,
the Price/Book method, the Price/Earnings method, and Price/Assets method, all
of which are described in its report. Keller & Company placed the greatest
emphasis on the Price/Earnings and Price/Book methods in estimating pro forma
market value. In applying these procedures, Keller & Company reviewed, among
other factors, the economic make-up of Security Federal's primary market area,
Security Federal's financial performance and condition in relation to publicly
traded institutions that Keller & Company deemed comparable to Security Federal,
the specific terms of the offering of Security Financial's common stock, the pro
forma impact of the additional capital raised in the conversion, conditions of
securities markets in general, and the market for thrift institution common
stock in particular. Keller & Company's analysis provides an approximation of
the pro forma market value of Security Financial and Security Federal as
converted based on the valuation methods applied and the assumptions outlined in
its report. Included in its report were certain assumptions as to the pro forma
earnings of Security Financial after the conversion that were utilized in
determining the appraised value. These assumptions included estimated expenses
and an assumed after-tax rate of return on the net conversion proceeds as
described under "Pro Forma Data," purchases by the employee stock ownership plan
of 8% of the common stock sold in the conversion and purchases in the open
market by the stock-based incentive plan of a number of shares equal to 4% of
the common stock sold in the conversion at the $10.00 purchase price. See "Pro
Forma Data" for additional information concerning these assumptions. The use of
different assumptions may yield different results.
On the basis of the foregoing, Keller & Company has advised Security
Financial and Security Federal that, in its opinion, as of October 20, 1999, the
aggregate estimated pro forma market value of Security Financial and Security
Federal, as converted and, therefore, the common stock was within the valuation
range of $15,725,000 to $21,275,000 with a midpoint of $18,500,000. After
reviewing the methodology and the assumptions used by Keller & Company in the
preparation of the appraisal, the Board of Directors established the estimated
valuation range which is equal to the valuation range of $15,725,000 to
$21,275,000 with a midpoint of $18,500,000. Assuming that the shares are sold at
$10.00 per share in the conversion, the estimated number of shares would be
between 1,572,500 and 2,127,500 with a midpoint of 1,850,000. The purchase
price of $10.00 was determined by discussion among the Boards of Directors of
Security Federal and Security Financial and Webb, taking into account, among
other factors, the requirement under Office of Thrift Supervision regulations
that the common stock be offered in a manner that will achieve the widest
distribution of the stock, and desired liquidity in the common stock after the
conversion. Since the outcome of the offering relates in large measure to market
conditions at the time of sale, it is not possible to determine the exact number
of shares that will be issued by Security Financial at this time. The estimated
valuation range may be amended, with the approval of the Office of Thrift
Supervision, if necessitated by developments following the date of the appraisal
in, among other things, market conditions, the financial condition or operating
results of Security Federal, regulatory guidelines or national or local economic
conditions. Keller & Company's appraisal report is filed as an exhibit to the
registration statement that Security Financial has filed with the Securities and
Exchange Commission. See "Where You Can Find More Information."
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If, upon completion of the subscription offering, at least the minimum
number of shares are subscribed for, Keller & Company, after taking into account
factors similar to those involved in its prior appraisal, will determine its
estimate of the pro forma market value of Security Financial and Security
Federal as converted, as of the close of the subscription offering.
No shares will be sold unless Keller & Company confirms to the Office of
Thrift Supervision that, to the best of its knowledge and judgment, nothing of a
material nature has occurred that would cause it to conclude that the actual
total purchase price on an aggregate basis was incompatible with its estimate of
the total pro forma market value of Security Financial and Security Federal as
converted at the time of the sale. If, however, the facts do not justify that
statement, the offering may be canceled, a new estimated valuation range and
price per share set and new subscription, direct community and syndicated
community offerings held. Under circumstances, subscribers would have the right
to modify or rescind their subscriptions and to have their subscription funds
returned promptly with interest and holds on funds authorized for withdrawal
from deposit accounts would be released or reduced.
Depending upon market and financial conditions, the number of shares issued
may be more than 2,446,625 shares or less than 1,572,500 shares. If the total
amount of shares issued is less than 1,572,500 or more than 2,446,625 for
aggregate gross proceeds of less than $15,725,000 or more than $24,466,250,
subscription funds will be returned promptly with interest to each subscriber
unless he indicates otherwise. If Keller & Company establishes a new valuation
range, it must be approved by the Office of Thrift Supervision.
If purchasers cannot be found for an insignificant residue of unsubscribed
shares from the general public, other purchase arrangements will be made by the
Boards of Directors of Security Federal and Security Financial, if possible.
Other purchase arrangements must be approved by the Office of Thrift Supervision
and may provide for purchases for investment purposes by directors, officers,
their associates and other persons in excess of the limitations provided in the
plan of conversion and in excess of the proposed director purchases discussed
earlier, although no purchases are currently intended. If other purchase
arrangements cannot be made, the plan of conversion will terminate.
In formulating its appraisal, Keller & Company relied upon the
truthfulness, accuracy and completeness of all documents Security Federal
furnished to it. Keller & Company also considered financial and other
information from regulatory agencies, other financial institutions, and other
public sources, as appropriate. While Keller & Company believes this information
to be reliable, Keller & Company does not guarantee the accuracy or completeness
of the information and did not independently verify the financial statements and
other data provided by Security Federal and Security Financial or independently
value the assets or liabilities of Security Financial and Security Federal. The
appraisal is not intended to be, and must not be interpreted as, a
recommendation of any kind as to the advisability of voting to approve the plan
of conversion or of purchasing shares of common stock. Moreover, because the
appraisal must be based on many factors which change periodically, there is no
assurance that purchasers of shares in the conversion will be able to sell
shares after the conversion at prices at or above the purchase price.
Limitations on Purchases of Shares
The plan of conversion provides for certain limitations to be placed upon
the purchase of common stock by eligible subscribers and others in the
conversion. Each subscriber must subscribe for a minimum of 25 shares. The plan
of conversion provides for the following purchase limitations:
. No eligible subscriber (including all persons on a joint account) may
purchase more than $200,000 of common stock in the subscription
offering. All persons on a joint account will be counted as a single
depositor for purposes of determining the maximum amount that may be
subscribed for by owners of a joint account;
. The ESOP may purchase, in the aggregate, up to 8% of the shares of
common stock sold in the conversion;
94
. No person may purchase more than $200,000 of common stock in the
direct community offering;
. No person may purchase more than $200,000 of common stock in the
syndicated community offering; and
. No person, either alone or together with associates of or persons
acting in concert with such person, may purchase in the aggregate more
than the overall maximum purchase limitation of $400,000 of common
stock.
For purposes of the plan of conversion, the directors are not deemed to be
acting in concert solely by reason of their Board membership. Pro rata
reductions within each subscription rights category will be made in allocating
shares if the maximum purchase limitations are exceeded.
Security Federal's and Security Financial's Boards of Directors may, in
their sole discretion, increase the maximum purchase limitation up to 9.99% of
the shares of common stock sold in the conversion, provided that orders for
shares which exceed 5% of the shares of common stock sold in the conversion may
not exceed, in the aggregate, 10% of the shares sold in the conversion. Security
Federal and Security Financial do not intend to increase the maximum purchase
limitation unless market conditions warrant an increase in the maximum purchase
limitation and the sale of a number of shares in excess of the minimum of the
estimated valuation range. If the Boards of Directors decide to increase the
purchase limitation above, persons who subscribed for the maximum number of
shares of common stock will be, and other large subscribers in the discretion of
Security Financial and Security Federal may be, given the opportunity to
increase their subscriptions accordingly, based on the rights and preferences of
any person who has priority subscription rights.
The plan of conversion defines "acting in concert" to mean knowing
participation in a joint activity or interdependent conscious parallel action
towards a common goal whether or not by an express agreement; or a combination
or pooling of voting or other interests in the securities of an issuer for a
common purpose under any contract, understanding, relationship, agreement or
other arrangement, whether written or otherwise. In general, a person who acts
in concert with another party shall also be deemed to be acting in concert with
any person who is also acting in concert with that other party. Security
Financial and Security Federal may presume that certain persons are acting in
concert based upon, among other things, joint account relationships and the fact
that persons may have filed joint Schedules 13D with the Securities and Exchange
Commission with respect to other companies.
The plan of conversion defines "associate," with respect to a particular
person, to mean any corporation or organization other than Security Federal or a
majority-owned subsidiary of Security Federal of which a person is an officer or
partner or is, directly or indirectly, the beneficial owner of 10% or more of
any class of equity securities; any trust or other estate in which a person has
a substantial beneficial interest or as to which a person serves as trustee or
in a similar fiduciary capacity; and any relative or spouse of a person, or any
relative of a spouse, who either has the same home as a person or who is a
director or officer of Security Federal or any of its parents or subsidiaries.
For example, a corporation of which a person serves as an officer would be an
associate of a person and, therefore, all shares purchased by a corporation
would be included with the number of shares which a person could purchase
individually under the above limitations.
The plan of conversion defines "officer" to mean an executive officer of
Security Federal, including its Chairman of the Board, President, Executive Vice
Presidents, Senior Vice Presidents, Vice Presidents in charge of principal
business functions, Secretary and Treasurer.
Common stock purchased in the conversion will be freely transferable,
except for shares purchased by directors and officers of Security Federal and
Financial and by NASD members. See "--Restrictions on Transferability
by Directors and Officers and NASD Members."
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Restrictions on Repurchase of Stock
Under Office of Thrift Supervision regulations, savings associations and
their holding companies may not for a period of three years from the date of an
institution's mutual-to-stock conversion repurchase any of its common stock from
any person, except in an offer made to all of its stockholders to repurchase the
common stock on a pro rata basis, approved by the Office of Thrift Supervision
or the repurchase of qualifying shares of a director. Furthermore, repurchases
of any common stock are prohibited if they would cause the association's
regulatory capital to be reduced below the amount required for the liquidation
account or the regulatory capital requirements imposed by the Office of Thrift
Supervision. Repurchases are generally prohibited during the first year
following conversion. Upon ten days' written notice to the Office of Thrift
Supervision, and if the Office of Thrift Supervision does not object, an
institution may make open market repurchases of its outstanding common stock
during years two and three following the conversion, provided that certain
regulatory conditions are met and that the repurchase would not adversely affect
the financial condition of the institution. Any repurchases of common stock by
Security Financial must meet these regulatory restrictions unless the Office of
Thrift Supervision would provide otherwise.
Restrictions on Transferability by Directors and Officers and NASD Members
Shares of common stock purchased by directors and officers of Security
Financial may not be sold for a period of one year following the conversion,
except upon the death of the stockholder or in any exchange of the common stock
in connection with a merger or acquisition of Security Financial. Shares of
common stock received by directors or officers through the employee stock
ownership plan or the stock-based incentive plan or upon exercise of options
issued under the stock-based incentive plan or purchased after the conversion
are free of this restriction. Accordingly, shares of common stock issued by
Security Financial to directors and officers shall bear a legend giving
appropriate notice of the restriction and, in addition, Security Financial will
give appropriate instructions to the transfer agent for Security Financial's
common stock with respect to the restriction on transfers. Any shares issued to
directors and officers as a stock dividend, stock split or otherwise with
respect to restricted common stock shall also be restricted.
Purchases of outstanding shares of common stock of Security Financial by
directors, executive officers, or any person who was an executive officer or
director of Security Federal after adoption of the plan of conversion, and their
associates during the three-year period following the conversion may be made
only through a broker or dealer registered with the SEC, except with the prior
written approval of the Office of Thrift Supervision. This restriction does not
apply, however, to negotiated transactions involving more than 1% of Security
Financial's outstanding common stock or to the purchase of stock under the
stock-based incentive plan.
Security Financial has filed with the Securities and Exchange Commission a
registration statement under the Securities Act of 1933, as amended, for the
registration of the common stock to be issued in the conversion. This
registration does not cover the resale of the shares. Shares of common stock
purchased by persons who are not affiliates of Security Financial may be resold
without registration. Shares purchased by an affiliate of Security Financial
will have resale restrictions under Rule 144 of the Securities Act, as amended.
If Security Financial meets the current public information requirements of Rule
144, each affiliate of Security Financial who complies with the other conditions
of Rule 144, including those that require the affiliate's sale to be aggregated
with those of certain other persons, would be able to sell in the public market,
without registration, a number of shares not to exceed, in any three-month
period, the greater of 1% of the outstanding shares of Security Financial or the
average weekly volume of trading in the shares during the preceding four
calendar weeks. Provision may be made in the future by Security Financial to
permit affiliates to have their shares registered for sale under the Securities
Act of 1933, as amended, under certain circumstances.
Under guidelines of the National Association of Securities Dealers, Inc.,
members of that organization and their associates face certain restrictions on
the transfer of securities purchased with subscription rights and to certain
reporting requirements upon purchase of the securities.
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Interpretation, Amendment and Termination
To the extent permitted by law, all interpretations of the plan of
conversion by Security Federal will be final; however, such interpretations have
no binding effect on the Office of Thrift Supervision or the Federal Deposit
Insurance Corporation. The plan of conversion provides that, if deemed
necessary or desirable by the Board of Directors, the plan of conversion may be
substantively amended by the Board of Directors as a result of comments from
regulatory authorities or otherwise, without the further approval of Security
Federal's members.
Completion of the conversion requires the sale of all shares of the common
stock within 24 months following approval of the plan of conversion by Security
Federal's Board of Directors. If this condition is not satisfied, the plan of
conversion will be terminated and Security Federal will continue its business in
the mutual form of organization. The plan of conversion may be terminated by
the Board of Directors at any time.
RESTRICTIONS ON ACQUISITION OF SECURITY FINANCIAL
General
Security Federal's plan of conversion provides for the conversion of
Security Federal from the mutual to the stock form of organization and, in
connection therewith, the adoption of a new stock Charter and Bylaws by Security
Federal's members. The plan of conversion also provides for the concurrent
formation of a holding company. See "The Conversion--General." As described
below and elsewhere herein, certain provisions in Security Financial's
Certificate of Incorporation and Bylaws and in its management remuneration
provided for in the conversion, together with provisions of Delaware corporate
law, may have anti-takeover effects. In addition, Security Federal's Charter
and Bylaws and management remuneration provided for in the conversion may also
have "anti-takeover" effects. Finally, regulatory restrictions may make it
difficult for persons or companies to acquire control of either Security
Financial or Security Federal.
Restrictions in Security Financial's Certificate of Incorporation and Bylaws
Security Financial's Certificate of Incorporation and Bylaws contain
certain provisions that could make more difficult an acquisition of Security
Financial by means of a tender offer, proxy context or otherwise. Certain
provisions will also render the removal of the incumbent Board of Directors or
management of Security Financial more difficult. These provisions may have the
effect of deterring a future takeover attempt that is not approved by the
Security Financial Board, but which Security Financial shareholders may deem to
be in their best interests or in which shareholders may receive a substantial
premium for their shares over then current market prices. As a result,
shareholders who might desire to participate in such a transaction may not have
the opportunity to do so. The following description of these provisions is only
a summary and does not provide all of the information contained in Security
Financial's Certificate of Incorporation and Bylaws. See "Where You Can Find
More Information" as to where to obtain a copy of these documents.
Business Combinations with Related Persons. The Certificate of
Incorporation require the approval of the holders of at least 80% of Security
Financial's outstanding shares of voting stock to approve certain "business
combinations" involving a "related person" except in cases where the proposed
transaction has been approved in advance by a majority of those members of
Security Financial's Board of Directors who are unaffiliated with the related
person and were directors prior to the time when the related person became a
related person.
The term "related person" includes any individual that owns beneficially or
controls, directly or indirectly, 10% or more of the outstanding shares of
voting stock of Security Financial or an affiliate of such person or entity.
97
A "business combination" includes:
. any merger or consolidation of Security Financial with or into any
related person;
. any sale, lease, exchange, mortgage, transfer, or other disposition of
25% or more of the assets of Security Financial or combined assets of
Security Financial and its subsidiaries to a related person;
. any merger or consolidation of a related person with or into Security
Financial or a subsidiary of Security Financial;
. any sale, lease, exchange, transfer, or other disposition of 25% or
more of the assets of a related person to Security Financial or a
subsidiary of Security Financial;
. the issuance of any securities of Security Financial or a subsidiary
of Security Financial to a related person;
. the acquisition by Security Financial or a subsidiary of Security
Financial of any securities of a related person;
. any reclassification of common stock of Security Financial or any
recapitalization involving the common stock of Security Financial; or
. any agreement or other arrangement providing for any of the foregoing.
Limitation on Voting Rights. The Certificate of Incorporation of Security
Financial provide that no record owner of any outstanding Security Financial
common stock which is beneficially owned, directly or indirectly, by a person
who beneficially owns in excess of 10% of the then outstanding shares of
Security Financial common stock will be entitled or permitted to any vote in
respect of the shares held in excess of the 10% limit, unless permitted by a
resolution adopted by a majority of the Board of Directors. Beneficial
ownership is determined pursuant to the federal securities laws and includes
shares beneficially owned by such person or any of his or her affiliates (as
defined in the Certificate of Incorporation), shares which such person or his or
her affiliates have the right to acquire upon the exercise of conversion rights
or options and shares as to which such person and his or her affiliates have or
share investment or voting power, but does not include shares beneficially owned
by directors, officers and employees of Security Federal or Security Financial
or shares that are subject to a revocable proxy and that are not otherwise
beneficially, or deemed by Security Financial to be beneficially, owned by such
person and his or her affiliates.
Evaluation of Offers. The Certificate of Incorporation of Security
Financial further provides that the Board of Directors of Security Financial,
when evaluating an offer, to (1) make a tender or exchange offer for any equity
security of Security Financial, (2) merge or consolidate Security Financial with
another corporation or entity or (3) purchase or otherwise acquire all or
substantially all of the properties and assets of Security Financial, may, in
connection with the exercise of its judgment in determining what is in the best
interest of Security Financial and the stockholders of Security Financial, give
consideration to those factors that directors of any subsidiary (including
Security Federal) may consider in evaluating any action that may result in a
change or potential change in control of such subsidiary, and the social and
economic effects of acceptance of such offer on: Security Financial's present
and future customers and employees and those of its subsidiaries (including
Security Federal); the communities in which Security Financial and Security
Federal operate or are located; the ability of Security Financial to fulfill its
corporate objectives as a savings and loan holding company; and the ability of
Security Federal to fulfill the objectives of a stock savings bank under
applicable statutes and regulations. By having these standards in the
Certificate of Incorporation of Security Financial, the Board of Directors may
be in a stronger position to oppose such a transaction if the Board concludes
that the transaction would not be in the best interest of Security Financial,
even if the price offered is significantly greater than the then market price of
any equity security of Security Financial.
98
Board of Directors
Classified Board. The Board of Directors of Security Financial is divided
into three classes, each of which contains approximately one-third of the number
of directors. The shareholders elect one class of directors each year for a
term of three years. The classified Board makes it more difficult and time
consuming for a shareholder group to fully use its voting power to gain control
of the Board of Directors without the consent of the incumbent Board of
Directors of Security Financial.
Filling of Vacancies; Removal. The Certificate of Incorporation provides
that any vacancy occurring in the Security Financial Board, including a vacancy
created by an increase in the number of directors, may be filled by a vote of a
majority of the directors then in office. The Certificate of Incorporation of
Security Financial provide that a director may be removed from the Board of
Directors prior to the expiration of his or her term only for cause and only
upon the vote of two-thirds of the outstanding shares of voting stock. These
provisions make it more difficult for shareholders to remove directors and
replace them with their own nominees.
Shareholder Action by Written Consent; Special Meetings of Shareholders.
Stockholders of Security Financial must act only through an annual or special
meeting. Stockholders cannot act by written consent in lieu of a meeting. The
Certificate of Incorporation provide that only the Chairman or a majority of the
Board of Directors of Security Financial may call special meetings of the
shareholders of Security Financial. Shareholders are not able to call a special
meeting or require that the Board do so. At a special meeting, shareholders may
consider only the business specified in the notice of meeting given by Security
Financial. The provisions of Security Financial's Certificate of Incorporation
prohibiting stockholder action by written consent may have the effect of
delaying consideration of a shareholder proposal until the next annual meeting,
unless a special meeting is called by the Chairman or at the request of a
majority of the Board of Directors. These provisions also would also prevent
the holders of a majority of common stock from unilaterally using the written
consent procedure to take shareholder action. Moreover, a shareholder could not
force shareholder consideration of a proposal between annual meetings over the
opposition of the Chairman and the Security Financial Board by calling a special
meeting of shareholders.
Advance Notice Provisions for Shareholder Nominations and Proposals. The
Security Financial Bylaws establish an advance notice procedure for shareholders
to nominate directors or bring other business before an annual meeting of
shareholders of Security Financial. A person may not be nominated for election
as a director unless that person is nominated by or at the direction of the
Security Financial Board or by a shareholder who has given appropriate notice to
Security Financial before the meeting. Similarly, a shareholder may not bring
business before an annual meeting unless the shareholder has given Security
Financial appropriate notice of its intention to bring that business before the
meeting. Security Financial's Secretary must receive notice of the nomination
or proposal not less than 30 nor more than 60 days prior to the annual meeting.
A shareholder who desires to raise new business must provide certain information
to Security Financial concerning the nature of the new business, the shareholder
and the shareholder's interest in the business matter. Similarly, a shareholder
wishing to nominate any person for election as a director must provide Security
Financial with certain information concerning the nominee and the proposing
shareholder.
Advance notice of nominations or proposed business by shareholders gives
the Security Financial Board time to consider the qualifications of the proposed
nominees, the merits of the proposals and, to the extent deemed necessary or
desirable by the Security Financial Board, to inform shareholders and make
recommendations about those matters.
Preferred Stock. The Certificate of Incorporation authorizes the Security
Financial Board to establish one or more series of preferred stock and, for any
series of preferred stock, to determine the terms and rights of the series,
including voting rights, conversion rates, and liquidation preferences.
Although the Security Financial Board has no intention at the present time of
doing so, it could issue a series of preferred stock that could, depending on
its terms, impede a merger, tender offer or other takeover attempt. The
Security Financial Board will make any determination to issue shares with those
terms based on its judgment as to the best interests of Security Financial and
its shareholders.
99
Amendment of Certificate of Incorporation. Security Financial's
Certificate of Incorporation require the affirmative vote of at least two-thirds
of the outstanding voting stock entitled to vote to amend or repeal certain
provisions of the Certificate of Incorporation, including the provision limiting
voting rights, the provisions relating to approval of business combinations with
related persons, calling special meetings, the number and classification of
directors, director and officer indemnification by Security Financial and
amendment of Security Financial's Bylaws and Certificate of Incorporation. These
supermajority voting requirements make it more difficult for the shareholders to
amend these provisions of the Security Financial Certificate of Incorporation.
Anti-Takeover Effects of Security Financial's Certificate of Incorporation and
Bylaws and Management Remuneration Adopted in Conversion
The provisions described above are intended to reduce Security Financial's
vulnerability to takeover attempts and other transactions which have not been
negotiated with and approved by members of its Board of Directors. Provisions of
the Stock-Based Incentive Plan provide for accelerated benefits to participants
if a change in control of Security Financial or Security Federal occurs or a
tender or exchange offer for their stock is made. See "Management of Security
Federal--Benefits--Stock-Based Incentive Plan." Security Financial and Security
Federal have also entered into agreements with key officers and intends to
establish the Severance Compensation Plan which will provide such officers and
eligible employees with additional payments and benefits on the officer's
termination in connection with a change in control of Security Financial or
Security Federal. See "Management of Security Federal--Executive Compensation--
Employment Agreements," and "Benefits--Employee Severance Compensation Plan."
The foregoing provisions and limitations may make it more difficult for
companies or persons to acquire control of Security Financial. Additionally, the
provisions could deter offers to acquire the outstanding shares of Security
Financial which might be viewed by stockholders to be in their best interests.
Security Financial's Board of Directors believes that the provisions of the
Certificate of Incorporation and Bylaws are in the best interest of Security
Financial and its stockholders. An unsolicited non-negotiated takeover proposal
can seriously disrupt the business and management of a corporation and cause it
great expense. Accordingly, the Board of Directors believes it is in the best
interests of Security Financial and its stockholders to encourage potential
acquirors to negotiate directly with management and that these provisions will
encourage such negotiations and discourage non-negotiated takeover attempts.
Delaware Corporate Law
The State of Delaware has a statute designed to provide Delaware
corporations with additional protection against hostile takeovers. The Delaware
takeover statute is intended to discourage certain takeover practices by
impeding the ability of a hostile acquiror to engage in certain transactions
with the target company.
In general, the statute provides that a "Person" who owns 15% or more of
the outstanding voting stock of a Delaware corporation (an Interested
Stockholder) may not consummate a merger or other business combination
transaction with such corporation at any time during the three-year period
following the date such "Person" became an Interested Stockholder. The term
"business combination" is defined broadly to cover a wide range of corporate
transactions including mergers, sales of assets, issuances of stock,
transactions with subsidiaries and the receipt of disproportionate financial
benefits.
The statute exempts the following transactions from the requirements of the
statute: (1) any business combination if, before the date a person became an
Interested Stockholder, the board of directors approved either the business
combination or the transaction which resulted in the stockholder becoming an
Interested Stockholder; (2) any business combination involving a person who
acquired at least 85% of the outstanding voting stock in the transaction in
which he became an Interested Stockholder, excluding, for purposes of
determining the number of shares outstanding, shares owned by the corporation's
directors who are also officers and specific employee stock plans; (3) any
business combination with an Interested Stockholder that is approved by the
board of directors and by a two-thirds vote of the outstanding voting stock not
owned by the Interested Stockholder; and (4) certain business combinations that
are
100
proposed after the corporation had received other acquisition proposals and
which are approved or not opposed by a majority of certain continuing members of
the board of directors. A corporation may exempt itself from the requirements of
the statute by adopting an amendment to its certificate of incorporation or
bylaws electing not to be governed by Section 203. At the present time, the
Board of Directors does not intend to propose any such amendment.
Restrictions in Security Federal's New Charter and Bylaws
Although the Board of Directors of Security Federal is not aware of any
effort that might be made to obtain control of Security Federal after the
conversion, the Board of Directors believes that it is appropriate to adopt
provisions permitted by federal regulations to protect the interests of the
converted bank and its stockholders from any hostile takeover. Such provisions
may, indirectly, inhibit a change in control of Security Financial, as Security
Federal's sole stockholder. See "Risk Factors--Anti-takeover provisions and
statutory provisions could make takeover attempts that shareholders want more
difficult to achieve."
Security Federal's stock charter will contain a provision whereby the
acquisition of beneficial ownership of more than 10% of the issued and
outstanding shares of any class of equity securities of Security Federal by any
person (i.e., any individual, corporation, group acting in concert, trust,
partnership, joint stock company or similar organization), either directly or
through an affiliate thereof, will be prohibited for a period of three years
following the date of completion of the conversion without the prior written
approval of the Office of Thrift Supervision. If shares are acquired in
violation of this provision of Security Federal's stock Charter, all shares
beneficially owned by any person in excess of 10% shall be considered "excess
shares" and shall not be counted as shares entitled to vote and shall not be
voted by any person or counted as voting shares in connection with any matters
submitted to the stockholders for a vote. This limitation shall not apply to
any transaction in which Security Federal forms a holding company without a
change in the respective beneficial ownership interests of its stockholders
other than by the exercise of any dissenter or appraisal rights. If holders of
revocable proxies for more than 10% of the shares of the common stock of
Security Financial seek, among other things, to elect one-third or more of
Security Financial's Board of Directors, to cause Security Financial's
stockholders to approve the acquisition or corporate reorganization of Security
Financial or to exert a continuing influence on a material aspect of the
business operations of Security Financial, which actions could indirectly result
in a change in control of Security Federal, the Board of Directors of Security
Federal will be able to assert this provision of Security Federal's stock
Charter against such holders. Although the Board of Directors of Security
Federal is not currently able to determine when and if it would assert this
provision of Security Federal's stock Charter, the Board, in exercising its
fiduciary duty, may assert this provision if it were deemed to be in the best
interests of Security Federal, Security Financial and its stockholders. It is
unclear, however, whether this provision, if asserted, would be successful
against such persons in a proxy contest which could result in a change in
control of Security Federal indirectly through a change in control of Security
Financial.
In addition, stockholders will not be permitted to cumulate their votes in
the election of Directors. Furthermore, Security Federal's Bylaws provide for
the election of three classes of directors to staggered terms. The staggered
terms of the Board of Directors could have an anti-takeover effect by making it
more difficult for a majority of shares to force an immediate change in the
Board of Directors since only one-third of the Board is elected each year. The
purpose of these provisions is to assure stability and continuity of management
of Security Federal in the years immediately following the conversion.
Finally, the stock Charter provides for the issuance of shares of preferred
stock on such terms, including conversion and voting rights, as may be
determined by Security Federal's Board of Directors without stockholder
approval. Although Security Federal has no arrangements, understandings or
plans at the present time for the issuance or use of the shares of undesignated
preferred stock proposed to be authorized, the Board believes that the
availability of such shares will provide Security Federal with increased
flexibility in structuring possible future financings and acquisitions and in
meeting other corporate needs which may arise. If a proposed merger, tender
offer or other attempt to gain control of Security Federal occurs of which
management does not approve, the Board can authorize the issuance of one or more
series of preferred stock with rights and preferences which could impede the
completion of such a transaction. An effect of the possible issuance of such
preferred stock, therefore, may be to deter a future takeover
101
attempt. The Board does not intend to issue any preferred stock except on terms
which the Board deems to be in the best interest of Security Federal and its
then existing stockholders.
Regulatory Restrictions
Office of Thrift Supervision Conversion Regulations. Regulations issued by
the Office of Thrift Supervision provide that for a period of three years
following the date of the completion of the conversion, no person, acting singly
or together with associates in a group of persons acting in concert, shall
directly or indirectly offer to acquire or acquire the beneficial ownership of
more than ten percent (10%) of any class of any equity security of Security
Financial without the prior written approval of the Office of Thrift
Supervision. Where any person, directly or indirectly, acquires beneficial
ownership of more than ten percent (10%) of any class of any equity security of
Security Financial without the prior written approval of the Office of Thrift
Supervision, the securities beneficially owned by such person in excess of ten
percent (10%) shall not be voted by any person or counted as voting shares in
connection with any matter submitted to the stockholders for a vote, and shall
not be counted as outstanding for purposes of determining the affirmative vote
necessary to approve any matter submitted to the stockholders for a vote.
Change in Bank Control Act. The acquisition of ten percent (10%) or more
of the outstanding common stock of Security Financial may trigger the provisions
of the Change in Bank Control Act. The Office of Thrift Supervision has also
adopted a regulation under the Change in Bank Control Act which generally
requires persons who at any time intend to acquire control of a federally
chartered savings association, including a converted savings bank such as
Security Federal, or a savings and loan holding company, such as Security
Financial, to provide 60 days prior written notice and certain financial and
other information to the Office of Thrift Supervision.
The 60-day notice period does not commence until the information is deemed
to be substantially complete. Control for the purpose of this Act exists in
situations in which the acquiring party has voting control of at least twenty-
five percent (25%) of any class of Security Financial's voting stock or the
power to direct the management or policies of Security Financial. However,
under Office of Thrift Supervision regulations, control is presumed to exist
where the acquiring party has voting control of at least ten percent (10%) of
any class of Security Financial's voting securities if specified "control
factors" are present. The statute and underlying regulations authorize the
Office of Thrift Supervision to disapprove a proposed acquisition on certain
specified grounds.
DESCRIPTION OF CAPITAL STOCK OF SECURITY FINANCIAL
General
Security Financial is authorized to issue 4,000,000 shares of common stock
having a par value of $.01 per share and 1,000,000 shares of preferred stock
having a par value of $.01 per share. Security Financial currently expects to
issue up to 2,127,500 shares of common stock, unless increased to 2,446,625
shares of common stock sold. Security Financial will not issue any shares of
preferred stock in the conversion. Each share of Security Financial's common
stock will have the same relative rights as, and will be identical in all
respects with, each other share of common stock. Upon payment of the purchase
price for the common stock, as required by the plan of conversion, all stock
will be duly authorized, fully paid and nonassessable.
The common stock of Security Financial will represent nonwithdrawable
capital, will not be an account of any type, and will not be insured by the
Federal Deposit Insurance Corporation or any other government agency.
102
Common Stock
Dividends. Security Financial can pay dividends out of statutory surplus
or from certain net profits if, as and when declared by its Board of Directors.
The payment of dividends by Security Financial is limited by law and applicable
regulation. See "Dividend Policy" and "Regulation and Supervision." The holders
of common stock of Security Financial will be entitled to receive and share
equally in dividends as may be declared by the Board of Directors of Security
Financial out of funds legally available therefor. If Security Financial issues
preferred stock, the holders thereof may have a priority over the holders of the
common stock with respect to dividends.
Voting Rights. After the conversion, the holders of common stock of
Security Financial will possess exclusive voting rights in Security Financial.
They will elect Security Financial's Board of Directors and act on other matters
as are required to be presented to them under Delaware law or as are otherwise
presented to them by the Board of Directors. Except as discussed in
"Restrictions on Acquisition of Security Financial," each holder of common stock
will be entitled to one vote per share and will not have any right to cumulate
votes in the election of directors. If Security Financial issues preferred
stock, holders of Security Financial preferred stock may also possess voting
rights. Certain matters require a vote of 80% of the outstanding shares entitled
to vote. See "Restrictions on Acquisition of Security Financial."
As a federal mutual savings bank, corporate powers and control of Security
Federal are currently vested in its Board of Directors, who elect the officers
of Security Federal and who fill any vacancies on the Board of Directors. After
the conversion, voting rights will be vested exclusively in Security Financial,
which will own all of the outstanding capital stock of Security Federal, and
will be voted at the direction of Security Financial's Board of Directors.
Consequently, the holders of the common stock of Security Financial will not
have direct control of Security Federal.
Liquidation. If there is any liquidation, dissolution or winding up of
Security Federal, Security Financial, as the holder of Security Federal's
capital stock, would be entitled to receive all of Security Federal's assets
available for distribution after payment or provision for payment of all debts
and liabilities of Security Federal, including all deposit accounts and accrued
interest, and after distribution of the balance in the special liquidation
account to eligible account holders and supplemental eligible account holders.
Upon liquidation, dissolution or winding up of Security Financial, the holders
of its common stock would be entitled to receive all of the assets of Security
Financial available for distribution after payment or provision for payment of
all its debts and liabilities. If Security Financial issues preferred stock, the
preferred stock holders may have a priority over the holders of the common stock
upon liquidation or dissolution.
Preemptive Rights; Redemption. Holders of the common stock of Security
Financial will not be entitled to preemptive rights with respect to any shares
that may be issued. The common stock cannot be redeemed.
Preferred Stock
Security Financial will not issue any preferred stock in the conversion and
it has no current plans to issue any preferred stock after the conversion.
Preferred stock may be issued with designations, powers, preferences and rights
as the Board of Directors may from time to time determine. The Board of
Directors can, without stockholder approval, issue preferred stock with voting,
dividend, liquidation and conversion rights that could dilute the voting
strength of the holders of the common stock and may assist management in
impeding an unfriendly takeover or attempted change in control.
Restrictions on Acquisition
Acquisitions of Security Financial are restricted by provisions in its
Certificate of Incorporation and Bylaws and by the rules and regulations of
various regulatory agencies. See "Regulation and Supervision" and "Restrictions
on Acquisition of Security Financial."
103
REGISTRATION REQUIREMENTS
Security Financial has registered the common stock with the Securities and
Exchange Commission under Section 12(g) of the Securities Exchange Act of 1934,
as amended, and will not deregister its common stock for a period of at least
three years following the conversion. As a result of registration, the proxy and
tender offer rules, insider trading reporting and restrictions, annual and
periodic reporting and other requirements of that statute will apply.
LEGAL AND TAX OPINIONS
The legality of the common stock has been passed upon for Security
Financial by Muldoon, Murphy & Faucette LLP, Washington, D.C. The federal tax
consequences of the conversion have been opined upon by Muldoon, Murphy &
Faucette LLP and the Indiana tax consequences of the conversion have been opined
upon by Crowe, Chizek and Company LLP, Oak Brook, Illinois. Muldoon, Murphy &
Faucette LLP and Crowe, Chizek and Company LLP have consented to the references
to their opinions in this prospectus. Certain legal matters will be passed upon
for Charles Webb & Company, A Division of Keefe, Bruyette & Woods, Inc. by
Barnes & Thornburg, Indianapolis, Indiana.
EXPERTS
The consolidated financial statements of Security Federal at June 30, 1999
and 1998 and for each of the years ended June 30, 1999 and 1998 included in this
prospectus have been audited by Crowe, Chizek and Company LLP, Oak Brook,
Illinois, independent auditors, as stated in its report in the back of this
prospectus. These consolidated financial statements have been included in this
prospectus in reliance upon the report of Crowe, Chizek and Company LLP given
upon its authority as experts in accounting and auditing.
Keller & Company has consented to the summary in this prospectus of its
report to Security Federal setting forth its opinion as to the estimated pro
forma market value of Security Financial and Security Federal, as converted, and
its letter with respect to subscription rights, and to the use of its name and
statements with respect to it appearing in this prospectus.
WHERE YOU CAN FIND MORE INFORMATION
Security Financial has filed with the Securities and Exchange Commission a
Registration Statement on Form SB-2 (File No. 333-87397) under the Securities
Act of 1933, as amended, with respect to the common stock offered in the
conversion. This prospectus does not contain all the information contained in
the registration statement, certain parts of which are omitted as permitted by
the rules and regulations of the Securities and Exchange Commission. This
information may be inspected at the public reference facilities maintained by
the Securities and Exchange Commission at 450 Fifth Street, NW, Room 1024,
Washington, D.C. 20549 and at its regional offices at 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661; and 7 World Trade Center, Suite 1300, New
York, New York 10048. Copies may be obtained at prescribed rates from the Public
Reference Room of the Securities and Exchange Commission at 450 Fifth Street,
NW, Washington, D.C. 20549. The public may obtain information on the operation
of the Public Reference Room by calling the Securities and Exchange Commission
at 1-800-SEC-0330. The registration statement also is available through the
Securities and Exchange Commission's World Wide Web site on the Internet at
http://www.sec.gov.
Security Federal has filed with the Office of Thrift Supervision an
Application for Approval of Conversion, which includes proxy materials for
Security Federal's special meeting of members and certain other information.
This prospectus omits certain information contained in that application. The
application, including the proxy materials, exhibits and certain other
information included in the Application, may be inspected, without charge, at
the offices of the Office of Thrift Supervision, 1700 G Street, NW, Washington,
D.C. 20552 and at the offices of the Regional Director of the Office of Thrift
Supervision at the Central Regional Office of the Office of Thrift Supervision,
200 West Madison Street, Suite 1300, Chicago, Illinois 60606.
104
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
SECURITY FEDERAL BANK, A FEDERAL SAVINGS BANK
Page
----
Report of Independent Auditors........................................................... F-1
Consolidated Balance Sheets as of June 30, 1999 and 1998................................. F-2
Consolidated Statements of Operations for the Years Ended June 30, 1999 and 1998......... F-3
Consolidated Statements of Changes in Equity for the Years Ended June 30, 1999 and 1998.. F-4
Consolidated Statements of Cash Flows for the Years Ended June 30, 1999 and 1998......... F-5
Notes to Consolidated Financial Statements............................................... F-7
* * *
All schedules are omitted as the required information either is not
applicable or is included in the Consolidated Financial Statements or related
Notes.
Separate financial statements for Security Financial Bancorp, Inc. have not
been included in this prospectus because Security Financial Bancorp, Inc., which
has engaged in only organizational activities to date, has no significant
assets, contingent or other liabilities, revenues or expenses.
105
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Security Federal Bank, a Federal Savings Bank
St. John, Indiana
We have audited the accompanying consolidated balance sheets of Security Federal
Bank, a Federal Savings Bank and its wholly-owned subsidiaries as of June 30,
1999 and 1998, and the related consolidated statements of operations, changes in
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Bank's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Security Federal
Bank, a Federal Savings Bank and its wholly-owned subsidiaries as of June 30,
1999 and 1998, and the results of their operations and their cash flows for the
years then ended, in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
July 29, 1999
F-1
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
CONSOLIDATED BALANCE SHEETS
June 30, 1999 and 1998
(Dollars in thousands)
- --------------------------------------------------------------------------------
1999 1998
---- ----
ASSETS
Cash and due from financial institutions $ 3,175 $ 7,792
Interest-bearing deposits in financial institutions 1,345 710
-------- --------
Cash and cash equivalents 4,520 8,502
Securities available for sale 17,873 23,849
Loans held for sale 3,430 49,487
Loans receivable, net 148,316 180,845
Accrued interest receivable 1,034 1,495
Federal Home Loan Bank stock 5,300 5,300
Other real estate owned 295 481
Premises and equipment, net 5,766 5,652
Mortgage loan servicing rights 3,959 10,332
Other assets 1,002 2,135
-------- --------
Total assets $191,495 $288,078
======== ========
LIABILITIES AND EQUITY
Liabilities
Demand deposits $ 1,237 $ 17,698
Savings 45,356 46,948
NOW and money market 19,733 21,228
Time deposits, $100,000 and over 13,927 44,857
Other time deposits 85,641 103,645
-------- --------
165,894 234,376
Borrowed funds 5,000 31,815
Advances from borrowers for taxes and insurance 602 977
Accrued interest payable 59 153
Other liabilities 1,408 1,537
-------- --------
Total liabilities 172,963 268,858
Commitments and contingencies
Equity
Retained earnings, substantially restricted 18,592 19,200
Accumulated other comprehensive income (60) 20
-------- --------
Total equity 18,532 19,220
-------- --------
Total liabilities and equity $191,495 $288,078
======== ========
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-2
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30, 1999 and 1998
(Dollars in thousands)
- --------------------------------------------------------------------------------
1999 1998
---- ----
Interest and dividend income
Loans, including fees $15,806 $21,788
Securities 1,567 1,538
Other interest-earning assets 406 659
------- -------
17,779 23,985
Interest expense
Deposits 7,850 10,827
Borrowed funds 1,574 4,639
------- -------
9,424 15,466
------- -------
Net interest income 8,355 8,519
Provision for loan losses 750 550
------- -------
Net interest income after provision for loan losses 7,605 7,969
Noninterest income
Service charges and other fees 274 427
Loan servicing fees, net of amortization (516) (201)
Gain on sale of loans from secondary market activities 1,527 2,138
Gain on sale of loans transferred to held for sale - 1,632
Other 802 825
------- -------
2,087 4,821
Noninterest expense
Compensation and benefits 5,754 8,023
Occupancy and equipment 1,559 1,564
SAIF deposit insurance premium 281 172
Advertising and promotions 234 343
Data processing 813 821
Other 1,659 2,701
------- -------
10,300 13,624
------- -------
Loss before income taxes (608) (834)
Income tax benefit - -
------- ------
Net loss $ (608) $ (834)
======= ======
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-3
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Years ended June 30, 1999 and 1998
(Dollars in thousands)
Accumulated
Other
Retained Comprehensive Total
Earnings Income Equity
-------- ------ ------
Balance at July 1, 1997 $20,034 $ - $20,034
Comprehensive income:
Net loss (834) - (834)
Change in unrealized gain (loss)
on securities available for sale - 20 20
-------
Total comprehensive income (814)
-------- ------ -------
Balance at June 30, 1998 19,200 20 19,220
Comprehensive income:
Net loss (608) - (608)
Change in unrealized gain (loss)
on securities available for sale - (80) (80)
-------
Total comprehensive income (688)
-------- ------ -------
Balance at June 30, 1999 $18,592 $ (60) $18,532
======== ====== =======
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-4
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30, 1999 and 1998
(Dollars in thousands)
- --------------------------------------------------------------------------------
1999 1998
---------- ----------
Cash flows from operating activities
Net loss $ (608) $ (834)
Adjustments to reconcile net loss to net cash from
operating activities
Depreciation 644 657
Provision for loan losses 750 550
(Gain) loss on sale of foreclosed real estate (14) 4
Origination and purchase of loans held for sale (253,794) (301,764)
Proceeds from sales of loans held for sale 301,378 262,183
Origination of mortgage loan servicing rights (4,492) (5,116)
Gain on sale of loans from secondary
market activities (1,527) (2,138)
Gain on sale of loans transferred to held for sale - (1,632)
Amortization of mortgage loan servicing rights 2,067 2,792
Proceeds from sales of mortgage servicing rights 8,798 -
Accretion of discount on securities (217) (225)
Change in accrued interest receivable 461 125
Change in accrued interest payable (94) (212)
Change in other assets 1,133 (468)
Change in other liabilities (129) 166
--------- ---------
Net cash from operating activities 54,356 (45,912)
Cash flows from investing activities
Proceeds from maturities of securities
available-for-sale 33,380 18,878
Principal payments on securities available for sale 2,792 1,721
Purchase of securities available for sale (30,059) (29,663)
Proceeds from sales of other loans - 77,858
Purchase of Federal Home Loan Bank stock - (500)
Change in loans 31,601 (6,152)
Change in premises and equipment, net (758) (483)
Proceeds from sale of other real estate 378 376
--------- ---------
Net cash from investing activities 37,334 62,035
Cash flows from financing activities
Change in deposits (68,482) 50,887
Change in advance payments by borrowers for taxes
and insurance (375) (196)
Repayments of advances from Federal
Home Loan Bank (25,000) (46,000)
Change in Federal Home Loan Bank
overnight line of credit (1,815) (18,180)
--------- ---------
Net cash from financing activities (95,672) (13,489)
--------- ---------
- --------------------------------------------------------------------------------
(Continued)
F-5
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30, 1999 and 1998
(Dollars in thousands)
- --------------------------------------------------------------------------------
1999 1998
-------- -------
Net increase (decrease) in cash and cash equivalents $(3,982) $ 2,634
Cash and cash equivalents at beginning of year 8,502 5,868
------- -------
Cash and cash equivalents at end of year $ 4,520 $ 8,502
======= =======
Supplemental disclosures of cash flow information
Cash paid (refunded) during the year for
Interest $ 9,518 $15,678
Income taxes (511) 17
Transfer from loans to foreclosed real estate 178 739
Transfer from loans to loans held for sale - 76,226
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-6
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business: The accompanying consolidated financial statements include
- ------------------
the accounts of Security Federal Bank, a Federal Savings Bank ("the Bank") and
its wholly-owned subsidiaries, The Boulevard, Inc., Strategic Financial
Corporation, and Family Home Service Corporation, Inc. All significant
intercompany transactions and balances are eliminated in consolidation.
The Bank is a federally-chartered mutual savings bank and a member of the
Federal Home Loan Bank (FHLB) system. The Bank maintains insurance on savings
accounts with the Savings Association Insurance Fund (SAIF) of the Federal
Deposit Insurance Corporation.
The Bank is engaged in the business of residential and consumer lending to
customers primarily in northwest Indiana and Cook County, Illinois with
operations conducted through its main office and six branches in neighboring
communities. These communities are the source of substantially all of the
Bank's deposit and lending activities. The Bank is also involved in mortgage
banking through the origination and purchase of mortgage loans for the purpose
of securitization and sale as mortgage-backed securities with servicing for
secondary market agencies retained. Mortgage loans originated for resale are
originated primarily through its retail banking locations. The Bank also
purchases loans through approximately 75 correspondent relationships. The
Boulevard, Inc. sells insurance and brokerage services. Strategic Financial
Corporation and Family Home Service Corporation, Inc. are both inactive.
Use of Estimates: The preparation of financial statements in conformity with
- ----------------
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. The
estimates made by management that were most susceptible to change include the
allowance for loan losses, fair value of mortgage loan servicing rights, fair
value of loans held for sale, and the realization of deferred tax assets.
Cash Equivalents: For purposes of reporting cash flows, cash and cash
- ----------------
equivalents is defined to include the Bank's cash on hand, due from financial
institutions, and short-term interest-bearing deposits in financial
institutions. The Bank reports net cash flows for customer loan transactions,
deposit transactions, and deposits made with other financial institutions.
Securities: Securities are classified as held to maturity when the Bank has the
- ----------
positive intent and ability to hold those securities to maturity. Accordingly,
they are stated at cost, adjusted for amortization of premiums and accretion of
discounts. Securities are classified as available-for-sale when the Bank may
decide to sell those securities for changes in market interest rates, liquidity
needs, changes in yields on alternative investments, and for other reasons.
They are carried at fair value. Unrealized gains and losses on securities
available for sale are charged or
- --------------------------------------------------------------------------------
(Continued)
F-7
SECURITY FEDERAL BANK,a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
credited to a valuation allowance which is included as a separate component of
equity. Realized gains and losses on disposition are based on the net proceeds
and the adjusted carrying amount of the securities sold, using the specific
identification method.
Loans Held for Sale: Loans intended for sale in the secondary market are
- -------------------
carried at the lower of cost or estimated market value in the aggregate.
During 1999, the Bank adopted Statement of Financial Accounting Standards (SFAS)
No. 134, Accounting for Mortgage-Backed Securities After the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. The impact of
adopting SFAS No. 134 was not material to the consolidated financial statements.
Loans Receivable: Loans receivable are stated at unpaid principal balances,
- ----------------
less the allowance for loan losses and net of deferred loan origination fees and
discounts.
Recognition of Interest Income on Loans: Interest income on loans is recognized
- ---------------------------------------
over the term of the loans based on the principal balance outstanding. Unearned
interest on home improvement loans is amortized into income by the interest
method.
Loan Origination Fees, Commitment Fees, and Related Costs: Loan fees and
- ---------------------------------------------------------
certain direct loan origination costs are deferred, and the net fee or cost is
recognized as an adjustment to interest income using the interest method over
the contractual life of the loans, adjusted for estimated prepayments based on
the Bank's historical prepayment experience.
Allowance for Loans Losses: Because some loans may not be repaid in full, an
- --------------------------
allowance for loan losses is maintained. Increases to the allowance are
recorded by a provision for loan losses charged to expense. Estimating the risk
of loss and the amount of loss on any loan is necessarily subjective.
Accordingly, the valuation allowance is maintained at levels considered adequate
to cover losses, based on delinquencies, property appraisals, past loss
experience, general economic conditions, information about specific borrower
situations including their financial position, and other factors and estimates
which are subject to change over time. While management may periodically
allocate portions of the allowance for specific problem loan situations,
including impaired loans discussed below, the whole allowance is available for
any charge-offs that occur. Loans are charged off in whole or in part when
management's estimate of the undiscounted cash flows from the loan are less than
the recorded investment in the loan, although collection efforts continue and
future recoveries may occur.
- -------------------------------------------------------------------------------
(Continued)
F-8
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans considered to be impaired are reduced to the present value of expected
future cash flows or to the fair value of collateral, by allocating a portion of
the allowance for loan losses to such loans. If these allocations cause the
allowance for loan losses to require increase, such increase is reported as a
provision for loan losses.
Smaller balance homogenous loans are defined as residential first mortgage loans
secured by one-to-four-family residences, residential construction loans, and
share loans and are evaluated collectively for impairment. Commercial real
estate loans are evaluated individually for impairment. Normal loan evaluation
procedures, as described in the second preceding paragraph, are used to identify
loans which must be evaluated for impairment. Depending on the relative size of
the credit relationship, late or insufficient payments of 30 to 90 days will
cause management to reevaluate the credit under its normal loan evaluation
procedures. While the factors which identify a credit for consideration for
measurement of impairment or nonaccrual are similar, the measurement
considerations differ. A loan is impaired when management believes it is
probable they will be unable to collect all amounts due according to the
contractual terms of the loan agreement. A loan is placed on nonaccrual when
payments are more than 90 days past due unless the loan is adequately
collateralized and in the process of collection.
Mortgage Loan Servicing Rights: The Bank purchases and originates loans for
- ------------------------------
sale to the secondary market. When servicing on sold loans is retained, the
Bank capitalizes the cost of mortgage servicing rights, regardless of whether
those rights were acquired through purchase or origination activities.
The total cost of mortgage loans purchased or originated with the intent to sell
is allocated between the loan servicing right and the mortgage loan without
servicing, based on their relative fair values at the date of purchase or
origination (or date of sale). The capitalized cost of loan servicing rights is
amortized in proportion, to and over the period of, estimated net future
revenue.
Mortgage servicing rights are periodically evaluated for impairment. For
purposes of measuring impairment, mortgage servicing rights are stratified based
on predominant risk characteristics of the underlying serviced loans. These
risk characteristics include loan type (conventional or government insured,
fixed, or adjustable rate), term (15 year or 30 year), and note rate.
Impairment represents the excess of cost of an individual stratum of mortgage
servicing rights over its fair value and is recognized through a valuation
allowance.
The cost of acquiring the right to service mortgage loans is being amortized in
proportion to, and over the period of, estimated net servicing income using a
method which approximates the level-yield method.
- --------------------------------------------------------------------------------
(Continued)
F-9
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Real Estate Owned: Real estate properties acquired through, or in lieu
- -----------------------
of, loan foreclosures are initially recorded at the lower of cost or fair value,
less estimated selling expenses, at the date of foreclosure. Costs relating to
improvement of property are capitalized, whereas cost relating to the holding of
property are expensed.
Income Taxes: The Bank records income tax expense based on the amount of taxes
- ------------
due on its tax return, plus deferred taxes computed based on the expected future
tax consequences of temporary differences between the carrying amounts and tax
bases of assets and liabilities, using enacted tax rates. A valuation allowance
has been recorded to reduce deferred tax assets to the amount expected to be
realized.
Premises and Equipment: Land is carried at cost. Buildings and furniture,
- ----------------------
fixtures, and equipment are carried at cost, less accumulated depreciation.
Premises and equipment are depreciated using the straight-line method over the
estimated useful lives of the related assets which range from three to forty
years. Maintenance and repairs are expensed and improvements are capitalized.
Comprehensive Income: Comprehensive income consists of net income and
- --------------------
unrealized gains and losses on securities available for sale. Comprehensive
income reporting became effective July 1, 1998, with prior information restated
to be comparable.
NOTE 2 - SECURITIES
The amortized cost and fair value of securities available for sale are as
follows as of June 30:
---------------1 9 9 9--------------------
-------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
U.S. government
and federal agencies $13,963 $ 1 $ (71) $13,893
Mortgage-backed securities - issued
by FHLMC and FNMA 3,970 20 (10) 3,980
------- -------- ---- -------
$17,933 $ 21 $ (81) $17,873
======= ======== ==== =======
- -------------------------------------------------------------------------------
(Continued)
F-10
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- -------------------------------------------------------------------------------
NOTE 2 - SECURITIES (Continued)
--------------1 9 9 8---------------------
-------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U.S. government
and federal agencies $17,067 $ 15 $ (27) $17,055
Mortgage-backed securities - issued
by FHLMC and FNMA 6,673 42 (10) 6,705
Other asset-backed securities 89 - - 89
------- -------- ------- -------
$23,829 $ 57 $ (37) $23,849
======= ======== ======= =======
Amortized cost and fair value of debt securities available for sale by
contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may call or prepay obligations.
June 30, 1999
-------------
Amortized Fair
Cost Value
--------- -------
Due in one year or less $ 8,963 $ 8,982
Due in one to five years 5,000 4,911
Mortgage-backed securities 3,970 3,980
------- -------
$17,933 $17,873
======= =======
There were no sales of securities during 1999 or 1998.
- --------------------------------------------------------------------------------
(Continued)
F-11
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 3 - LOANS RECEIVABLE, NET
Loans receivable at June 30 are summarized as follows:
1999 1998
---- ----
Mortgage loans
Secured by 1-4 family residences $ 86,086 $102,556
Secured by commercial and multi-family properties 16,420 10,133
Construction loans 6,414 13,027
Automobile loans 15,980 25,059
Home equity and second mortgage loans 17,478 20,751
Commercial loans 5,867 8,480
Other consumer loans 1,616 2,361
-------- --------
149,861 182,367
Loans in process - (119)
Net deferred loan origination fees (76) (114)
Allowance for loan losses (1,469) (1,289)
-------- --------
$148,316 $180,845
======== ========
Activity in the allowance for loan losses is summarized as follows for the years
ended June 30:
1999 1998
-------- --------
Balance at beginning of year $ 1,289 $ 1,151
Provision charged to income 750 550
Charge-offs (586) (425)
Recoveries on loans previously charged off 16 13
-------- --------
Balance at end of year $ 1,469 $ 1,289
======== ========
There were no loans considered impaired as of or for the years ended June 30,
1999 and 1998.
Nonaccrual loans for which interest has been reduced totaled approximately
$2,107,000 and $2,941,000 at June 30, 1999 and 1998.
During 1999, management transferred loans held for sale totaling $7,167,000 into
the Bank's portfolio and recorded a loss of $34,000 upon the transfer.
The Bank's lending activities have been concentrated primarily in Lake and
Porter counties, Indiana, and Cook county, Illinois. The largest portion of the
Bank's loans are originated for the purpose of enabling borrowers to purchase
residential and real estate property secured by first liens on such property.
At June 30, 1999, approximately 57% of the Bank's loans were secured
- --------------------------------------------------------------------------------
(Continued)
F-12
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
by owner-occupied, one-to-four family residential property. The Bank requires
collateral on all loans and generally maintains loan-to-value ratios of 80% or
less.
- --------------------------------------------------------------------------------
(Continued)
F-13
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 4 - SEGMENT INFORMATION
The segment financial information provided below has been derived from the
internal financial reporting system used by management to monitor and manage the
financial performance of the Bank. The two reportable segments identified below
are the Bank's mortgage banking and banking operations. The accounting policies
of the two segments are the same as those described in the significant
accounting policies. Loan servicing fees and net gains from loan sales provide
the revenues in the mortgage banking operation while the interest income earned
on loans and securities less the interest paid on deposits and borrowings
provide the revenues in the banking operation. All operations are domestic.
Mortgage
June 30, 1999 Banking Banking Total
- ------------- ------- ------- -----
Net interest income $ 7,245 $ 1,110 $ 8,355
Provision for loan losses 750 - 750
Loan servicing fees, net of amortization - (516) (516)
Gain on sale of loans from secondary
market activity - 1,527 1,527
Other noninterest income 813 263 1,076
Compensation and benefits 4,170 1,584 5,754
Other noninterest expenses 1,520 3,026 4,546
-------- ------- --------
Income (loss) before income taxes $ 1,618 $(2,226) $ (608)
======== ======= ========
Segment assets $184,107 $ 7,388 $191,495
June 30, 1998
- -------------
Net interest income $ 7,285 $ 1,234 $ 8,519
Provision for loan losses 550 - 550
Loan servicing fees, net of amortization - (201) (201)
Gain on sale of loans from secondary
market activities - 2,138 2,138
Other noninterest income 2,428 456 2,884
Compensation and benefits 5,961 2,062 8,023
Other noninterest expenses 2,674 2,927 5,601
-------- ------- --------
Income (loss) before income taxes $ 528 $(1,362) $ (834)
======== ======= ========
Segment assets $228,259 $59,819 $288,078
- --------------------------------------------------------------------------------
(Continued)
F-14
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 5 - MORTGAGE LOAN SERVICING RIGHTS
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of these loans at
June 30 are summarized as follows:
1999 1998
-------- ----------
Mortgage loans underlying pass-through
securities
FNMA $ 85,564 $ 628,519
FHLMC 221,417 349,936
-------- ----------
306,981 978,455
Mortgage loan portfolios serviced for
FNMA 3,046 48,976
FHLMC 1,237 1,779
Other investors 10,874 15,120
-------- ----------
15,157 65,875
-------- ----------
$322,138 $1,044,330
======== ==========
During 1999, the Bank sold mortgage loan servicing rights with a carrying value
of $8,798,000 which resulted in a loss of $147,000 after selling expenses. The
principal amount of the loans related to these servicing rights totaled
approximately $920 million.
During 1998, the Bank transferred all conforming adjustable rate and jumbo
mortgage loans to loans held for sale, subsequently sold these loans, and
retained servicing on them. The book value of the loans which were transferred
was $76,226,000. The gain which resulted from these sales was $1,632,000.
Custodial balances maintained in connection with loan servicing were
approximately $1,282,000 and $17,759,000 at June 30, 1999 and 1998.
- --------------------------------------------------------------------------------
(Continued)
F-15
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 5 - MORTGAGE LOAN SERVICING RIGHTS (Continued)
Following is an analysis of the changes in mortgage loan servicing rights for
the years ended June 30, 1999 and 1998.
Balance at July 1, 1997 $ 8,008
Additions 5,116
Amortization (2,792)
-------
Balance at June 30, 1998 10,332
Additions 4,492
Sales of servicing rights (8,798)
Amortization (2,067)
-------
Balance, June 30, 1999 $ 3,959
=======
NOTE 6 - PREMISES AND EQUIPMENT, NET
Premises and equipment at June 30 are summarized as follows:
1999 1998
------ ------
Cost
Land $ 634 $ 308
Buildings and leasehold improvements 5,234 5,020
Furniture, fixtures, and equipment 2,757 2,571
------ ------
8,625 7,899
Less accumulated depreciation 2,859 2,247
------ ------
$5,766 $5,652
====== ======
NOTE 7 - ACCRUED INTEREST RECEIVABLE
Accrued interest consists of the following at June 30:
1999 1998
------ ------
Loans $ 903 $1,269
Securities 131 226
------ ------
$1,034 $1,495
====== ======
- --------------------------------------------------------------------------------
(Continued)
F-16
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 8 - DEPOSITS
The aggregate amount of certificate of deposit accounts with balances of
$100,000 or more at June 30, 1999 and 1998 was $13,927,000 and $44,857,000.
Deposits greater than $100,000 are not federally insured.
At June 30, 1999, scheduled maturities of certificates of deposit are as
follows:
2000 $ 80,016
2001 11,856
2002 3,776
2003 2,459
2004 and thereafter 1,461
--------
$ 99,568
========
Interest expense on deposits for the years ended June 30 is summarized as
follows:
1999 1998
-------- --------
NOW $ 111 $ 92
Money market 165 200
Savings 1,146 1,303
Certificates of deposit 6,428 9,232
-------- --------
$ 7,850 $ 10,827
======== ========
NOTE 9 - BORROWED FUNDS
Borrowed funds at June 30 are summarized as follows:
1999 1998
-------- --------
Advances from the Federal Home Loan Bank $ 5,000 $ 30,000
Line of credit from the Federal Home Loan Bank - 1,815
-------- --------
$ 5,000 $ 31,815
======== ========
Advances at June 30, 1999 have an interest rate of 5.4% and mature on October 4,
1999.
- --------------------------------------------------------------------------------
(Continued)
F-17
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 9 - BORROWED FUNDS (Continued)
At June 30, 1999, all Federal Home Loan Bank stock owned by the Bank and all
mortgage loans and mortgage-backed securities not otherwise pledged are pledged
to the Federal Home Loan Bank of Indianapolis to secure these advances. In
addition, the Bank has a total line of credit approved for $20,000,000 as of
June 30, 1999 with the Federal Home Loan Bank of Indianapolis. This line is
also secured by the collateral listed above.
NOTE 10 - EMPLOYEE BENEFITS
The Bank is part of a noncontributory multi-employer defined benefit pension
plan covering substantially all of its employees. The plan is administered by
the trustees of the Financial Institutions Retirement Fund. The Bank recognized
no pension expense for the years ended June 30, 1999 and 1998. Separate
financial data of this plan related to the Bank is not available.
The Bank maintains a 401(k) profit sharing plan covering substantially all
employees. The plan allows participant salary deferrals into the plan, as well
as contributions made at the discretion of the Board of Directors. The Bank
made no contributions to the plan for 1999 and 1998.
NOTE 11 - INCOME TAXES
Income tax benefit for the years ended June 30 is summarized as follows:
1999 1998
---- ----
Federal
Deferred $(190) $ (46)
Benefit of operating loss carryforward - (278)
Change in valuation allowance for
deferred tax assets 190 324
----- -----
Income tax benefit $ - $ -
===== =====
- --------------------------------------------------------------------------------
(Continued)
F-18
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES (Continued)
The deferred income taxes are due primarily to the temporary differences related
to depreciation, bad debt deduction, deferred loan fees, and the market value
adjustment for securities held for sale for tax purposes.
Total income tax benefit differed from the amounts computed by applying the
federal income tax rate at June 30 to income before income taxes as a result of
the following:
1999 1998
------ --------
Income taxes (benefit) at statutory rate of 34% $ (207) $ (283)
Other items, net 17 (41)
Increase in valuation allowance 190 324
------ -------
Income tax benefit $ - $ -
====== =======
The components of the net deferred taxes as of June 30 are as follows:
1999 1998
------ ------
Allowance for loan losses $ 582 $ 510
Deferred loan fees 30 45
Deferred compensation plans 66 80
Accrued compensation 14 61
Benefit of net operating loss carryforward 541 1,043
Other, net 69 82
------ -------
1,302 1,821
Mortgage servicing rights (406) (844)
Bad debt recapture (186) (224)
Unrealized loss on loans held for sale - (228)
Other, net (43) (48)
------ -------
(635) (1,344)
------ -------
667 477
Valuation allowance for deferred tax assets (667) (477)
------ -------
$ - $ -
====== =======
At June 30, 1999, the Bank has state operating loss carryforwards for tax return
purposes of $2,494,000, of which $660,000 expires at June 30, 2012 and
$1,834,000 expires on June 30, 2013, and a federal operating loss carryforward
for tax return purposes of $1,180,000 which expires on June 30, 2013.
- --------------------------------------------------------------------------------
(Continued)
F-19
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES (Continued)
Retained earnings at June 30, 1999 includes approximately $2,935,000 of bad debt
deductions for tax years prior to 1987 for which no deferred federal income tax
liability has been recorded. Tax legislation passed in August 1996 now requires
all thrift institutions to deduct a provision for bad debts for tax purposes
based on the actual loss experience and recapture the excess bad debt reserve
accumulated in the tax years after 1987.
NOTE 12 - REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory--and possibly additional discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth below) of
total and Tier I capital (as defined in the regulations) to risk-weighted assets
(as defined) and of Tier I capital (as defined) to average assets (as defined).
Management believes, as of June 30, 1999, that the Bank meets all capital
adequacy requirements to which it is subject.
As of June 30, 1999, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. There are no conditions or events since
that notification that management believes have changed the Bank's category.
The following is a reconciliation of the Bank's equity under generally accepted
accounting principles (GAAP) to regulatory capital at June 30:
1999 1998
------- -------
GAAP equity $18,532 $19,220
Disallowed investments in loan servicing assets (94) (89)
Unrealized gain on securities available for sale 60 (20)
------- -------
Tier I capital 18,498 19,111
Allowance for loan losses 1,259 1,195
------- -------
Total capital $19,757 $20,306
======= =======
- --------------------------------------------------------------------------------
(Continued)
F-20
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 12 - REGULATORY CAPITAL (Continued)
The Bank's actual and required capital amounts and rates are presented below (in
thousands):
Requirement
To Be Well
Requirement Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of June 30, 1999
Total Capital (to
risk-weighted assets) $19,757 14.9% $10,579 8.0% $13,223 10.0%
Tier 1 Capital (to
(risk-weighted assets) 18,498 14.0 5,289 4.0 7,934 6.0
Core Capital (to
adjusted assets) 18,498 9.6 7,684 4.0 9,605 5.0
As of June 30, 1998
Total Capital (to
risk-weighted assets) $20,306 10.6% $15,312 8.0% $19,152 10.0%
Tier 1 Capital (to
(risk-weighted assets) 19,111 10.0 7,661 4.0 11,491 6.0
Core Capital (to
adjusted assets) 19,111 6.6 11,518 4.0 14,398 5.0
NOTE 13 - COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Bank has various outstanding commitments
and contingent liabilities that are not reflected in the accompanying
consolidated financial statements.
The Bank has the following commitments outstanding at June 30:
1999 1998
---- ----
Commitments to fund loans $6,547 $48,845
Unused lines of credit 6,293 6,938
Letters of credit 647 703
Commitments to sell loans and loan pools 3,000 81,500
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(Continued)
F-21
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 13 - COMMITMENTS AND CONTINGENCIES (Continued)
Since certain commitments to make loans and lines of credit to fund loans in
process expire without being used, the amounts do not necessarily represent
future cash commitments. In addition, commitments used to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. The Bank's exposure to credit loss in the
event of nonperformance by the other party to these financial instruments is
represented by the contractual amount of these instruments. The Bank follows the
same credit policy to make such commitments as is followed for those loans
recorded on the consolidated balance sheet.
As of June 30, 1999, variable rate and fixed rate commitments to make loans
amounted to approximately $626,000 and $5,921,000. The interest rates on
variable rate commitments ranged from 6.750% to 7.375% and the interest rates on
fixed rate commitments ranged from 6.250% to 8.375%. As of June 30, 1998,
variable rate and fixed rate commitments to make loans amounted to approximately
$1,434,000 and $47,411,000. Since loan commitments may expire without being
used, the amounts do not necessarily represent future cash commitments.
Four of the Bank's branch facilities are leased under noncancelable lease
agreements which expire between 2002 and 2019. In addition to the monthly rent,
the Bank is charged its proportionate share of taxes and maintenance.
The future minimum commitments under the noncancelable leases at June 30 were:
2000 $ 347
2001 349
2002 351
2003 333
2004 315
Thereafter 2,135
------
$3,830
======
Rent expense approximated $202,000 and $217,000 for the years ended June 30,
1999 and 1998.
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(Continued)
F-22
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
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NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table shows the estimated fair values and the related carrying
values of the Bank's financial instruments at June 30, 1999 and 1998. Items
which are not financial instruments are not included.
----------------June 30,-----------------------
-------
1 9 9 9 1 9 9 8
------- -------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- --------- ----------
Financial assets
Cash and cash equivalents $ 4,520 $ 4,520 $ 8,502 $ 8,502
Securities available for sale 17,873 17,873 23,849 23,849
Federal Home Loan Bank stock 5,300 5,300 5,300 5,300
Loans held for sale 3,430 3,485 49,487 49,632
Loans receivable, net 148,316 150,185 180,845 181,275
Mortgage loan servicing rights 3,959 4,185 10,332 12,794
Accrued interest receivable 1,034 1,034 1,495 1,495
Financial liabilities
Demand deposits (1,237) (1,237) (17,698) (17,698)
Savings, NOW, and MMDA deposits (65,089) (65,089) (68,176) (68,176)
Time deposits (99,568) (99,952) (148,502) (149,206)
Borrowed funds (5,000) (5,000) (31,815) (32,148)
Advances from borrowers for
taxes and insurance (602) (602) (977) (977)
Accrued interest payable (59) (59) (153) (153)
For purposes of the above disclosures of estimated fair value, the following
assumptions were used as of June 30, 1999 and 1998. The estimated fair value for
cash and cash equivalents is considered to approximate cost. The estimated fair
value for securities available for sale and securities held to maturity is based
on quoted market values for the individual securities or for equivalent
securities. The estimated fair value of stock in Federal Home Loan Bank is
considered to approximate cost. The estimated fair value of loans held for sale
is based on quoted market values for equivalent loans. The estimated fair value
for loans receivable is based on estimates of the rate the Bank would charge for
similar loans at June 30, 1999 and 1998, applied for the estimated time period
until the loan is assumed to reprice or be paid. The estimated fair value of
mortgage loan servicing rights is based on valuation methodology which considers
current market conditions and the historical performance of the loans being
serviced.
The estimated fair value for demand, savings, NOW, and MMDA deposits and
advances from borrowers for taxes and insurance is based on their carrying
value. The estimated fair value for time deposits and borrowed funds is based
on estimates of the rate the Bank would pay on
- --------------------------------------------------------------------------------
(Continued)
F-23
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
such deposits and borrowed funds at June 30, 1999 and 1998, applied for the time
period until maturity. The estimated fair values for other financial instruments
and off-balance-sheet loan commitments approximate cost at June 30, 1999 and
1998 and are not considered significant to this presentation.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that were the Bank to have
disposed of such items at June 30, 1999 and 1998, the estimated fair values
would necessarily have been achieved at that date, since market values may
differ depending on various circumstances. Also, the use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. The estimated fair values at June 30, 1999 and
1998 should not necessarily be considered to apply at subsequent dates.
In addition, other assets and liabilities of the Bank that are not defined as
financial instruments are not included in the above disclosures, such as
property and equipment. Also, non-financial instruments typically not recognized
in the financial statements nevertheless may have value but are not included in
the above disclosures. These include, among other items, the estimated earnings
power of core deposit accounts, the earnings potential of loan servicing rights
related to the Bank's loan portfolio, the trained work force, customer goodwill,
and similar items.
NOTE 15 - ADOPTION OF PLAN OF CONVERSION (UNAUDITED)
On September 9, 1999, the Board of Directors of the Bank, subject to regulatory
approval and approval by the members of the Bank, adopted a Plan of Conversion
to convert from a federally-chartered mutual savings bank to a federal stock
savings bank with the adoption of a federal thrift charter, which was amended on
September 17, 1999. The conversion is expected to be accomplished through the
amendment of the Bank's charter to stock form, the formation of Security
Financial Bancorp, Inc. ("the Company"), which will acquire 100% of the Bank's
outstanding common stock upon the conversion of the Bank from mutual to stock
form, and the sale of the Company's common stock in an amount equal to the pro
forma market value of the Bank after giving effect to the conversion. A
subscription offering of the shares of common stock will be offered initially to
the Bank's eligible deposit account holders, then to other members of the Bank.
Any shares of common stock not sold in the subscription offering will be offered
for sale to the general public, giving preference to the Bank's market area.
- --------------------------------------------------------------------------------
(Continued)
F-24
SECURITY FEDERAL BANK, a FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999 and 1998
(Table amounts in thousands)
- --------------------------------------------------------------------------------
NOTE 15 - ADOPTION OF PLAN OF CONVERSION (UNAUDITED) (Continued)
The Board of Directors of the Bank intend to adopt an Employee Stock Ownership
Plan and the Company may adopt various stock option and incentive plans, subject
to ratification by the stockholders after conversion, if such stockholder
approval is required by any regulatory body having jurisdiction to require such
approval. In addition, the Board of Directors is authorized to enter into
employment contracts with key employees.
At the time of conversion, the Bank will establish a liquidation account in an
amount equal to its total net worth as of the latest statement of financial
condition appearing in the final prospectus. The liquidation account will be
maintained for the benefit of eligible depositors who continue to maintain their
accounts at the Bank after the conversion. The liquidation account will be
reduced annually to the extent that eligible depositors have reduced their
qualifying deposits. Subsequent increases will not restore an eligible account
holder's interest in the liquidation account. In the event of a complete
liquidation, each eligible depositor will be entitled to receive a distribution
from the liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held. The liquidation account balance is
not available for payment of dividends.
The Bank may not declare or pay cash dividends on or repurchase any of its
shares of capital stock if the effect thereof would cause its net worth to be
reduced below applicable regulatory requirements or the amount of the
liquidation accounts of such a declaration and payment would otherwise violate
regulatory requirements.
Conversion costs will be deferred and deducted from the proceeds of the shares
sold in the conversion. If the conversion is not completed, all costs will be
charged to expense. At June 30, 1999, no expenses have been deferred.
- --------------------------------------------------------------------------------
F-25
You should rely only on the information contained in this prospectus. Neither
Security Financial Bancorp, Inc. nor Security Federal Bank, a Federal Savings
Bank has authorized anyone to provide you with different information. This
prospectus does not constitute an offer to sell or a solicitation of an offer to
buy any of the securities offered by this prospectus to any person or in any
jurisdiction in which an offer or solicitation is not authorized or in which the
person making an offer or solicitation is not qualified to do so, or to any
person to whom it is unlawful to make an offer or solicitation in those
jurisdictions. Neither the delivery of this prospectus nor any sale hereunder
shall under any circumstances imply that there has been no change in the affairs
of Security Financial Bancorp, Inc. or Security Federal Bank, a Federal Savings
Bank since any of the dates as of which information is furnished in this
prospectus or since the date of this prospectus.
[Logo for Security Financial Bancorp, Inc.]
(Proposed Holding Company for Security Federal Bank & Trust)
2,127,500 Shares of Common Stock
--------
Prospectus
--------
CHARLES WEBB & COMPANY
A Division of
KEEFE BRUYETTE & WOODS, INC.
November 10, 1999
DEALER PROSPECTUS DELIVERY OBLIGATION
Until the later of December 13, 2000, or 25 days after the commencement of the
syndicated community offering of common stock, if any, all dealers that buy,
sell or trade these securities, whether or not participating in this offering,
may be required to deliver a prospectus. This is in addition to the dealers'
obligation to deliver a prospectus when acting as underwriters and with respect
to their unsold allotments or subscriptions.