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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
----- TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL ENDED DECEMBER 31, 1997
Commission File Number: 0-15624
SECOND BANCORP, INCORPORATED
(Exact name of registrant as specified in charter)
OHIO 34-1547453
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
108 MAIN AVENUE, SW, WARREN, OHIO 44482
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (330) 841-0123
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Name of each exchange
Title of each class on which registered
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None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, no par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes ___X___ No _______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements,
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 13, 1998 as reported on the Nasdaq National Market
System, was approximately $184,428,603. Shares of Common Stock held by each
officer and director and by each person who owns 5% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 13, 1998, registrant had outstanding 6,830,689 of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual shareholders' meeting to be held
on May 12, 1998 are incorporated by reference into Part III.
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PART I.
ITEM 1. BUSINESS.
General.
Second Bancorp, Incorporated, (the "Company") is a one-bank holding company
which owns The Second National Bank of Warren (the "Bank"), a Warren, Ohio based
commercial bank. Operating through twenty-six branches and one loan production
office, the Bank offers a wide range of commercial and consumer banking and
trust services primarily to business and individual customers in various
communities in a five county area in northeastern Ohio. At December 31, 1997,
the Company had consolidated total assets of $913 million, deposits of $703
million and shareholders' equity of $79 million. At June 30, 1997, the Bank had
the second highest market share in Trumbull County, Ohio, the fourth highest
market share in Ashtabula County, Ohio and the fourth highest market share in
Portage County, Ohio with 13.8%, 8.9% and 9.3% of all bank, thrift and credit
union deposits, respectively, according to an independent survey.
The Bank focuses its marketing efforts primarily on local independent commercial
and professional firms, the individuals who are the owners and principals of
such firms as well as the low-to-moderate to upper income retail customers in
the Bank's trade areas. In recent years, the Company has emphasized increased
commercial and direct consumer and real estate lending and market area
expansion. The Bank has de-emphasized its previous focus on indirect consumer
loan lending through local automobile dealers.
In 1997, Second Bancorp, Inc. posted yet another record year for asset growth
and profitability. The "Facts and Figures" of our annual report tell an
important story about a regional community bank that has a strategic vision for
itself. Moreover, they convey an important message to our shareholders,
customers, and employees that their investment is a solid one.
At Second National Bank, the facts and figures also encapsulate the efforts of
hundreds of employees and a management team who have embraced a set of core
values: timely service, accessibility, high performance employees, accuracy and
efficiency, effective communications. We believe that this approach to
business--instilling everything we do with value--sets us apart from other
financial institutions.
The pursuit of value directed all of our efforts in 1997: from expanded employee
benefits and the development of new products and services, to added customer
conveniences, innovative business lending, and major technological advancements.
The results yielded another year of growth and performance--and paved the way
for future achievement at Second National Bank.
CORE VALUES
In 1997, Second National Bank embarked on a year-long initiative that challenged
employees to adopt the Bank's core values as their own. As a result of this
initiative, our employees successfully incorporated Second National's core
values into their daily work performance, taking Second National's customer
service to a new level.
Because our value banking strategy relies heavily on the employees of Second
National Bank, we continued to make significant investments in our training,
recognition, and benefits programs. Second National made a major commitment to
its work force--and created a powerful recruitment and retention tool--by
offering additional benefits to part-time employees. Part-time staff now has
access to several new benefits, including medical coverage, life insurance, and
the flexible-savings program, in addition to a pension, 401(k) savings plan, and
a paid vacation.
Many Second National employees also continued to take advantage of Second
Bancorp, Inc.'s Dividend Reinvestment Program (DRIP). Of the 331 current
employees who have received a personal gift of Second Bancorp stock from the
Executive Management Committee and Boards of Directors during the last three
years, more than 90 percent are currently participating in the DRIP.
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CUSTOMER SERVICE
For our customers who equate value with convenience, Second National expanded
its network of automated teller machines in 1997 by installing 11 additional
ATMs. With 25 ATMs throughout our Northeast Ohio branch network, Second National
Bank is now more accessible and more competitive. We also expanded lobby hours
during the week and on Saturdays in several Ashtabula and Portage County offices
to accommodate customer needs.
NEW RAVENNA OFFICE
Second National began construction of a new office in the city of Ravenna in
Portage County, where the Bank maintains a significant and growing market share.
In early 1998, Second National's current Ravenna office will be relocated to a
new 3,000 square foot building with substantially expanded capabilities. The new
Ravenna branch will offer a full staff of specialized banking professionals in
addition to two auto-teller lanes, a drive-up ATM, and dedicated parking.
TECHNOLOGY: ALLTEL HORIZON BANKING SYSTEM
With the installation of a new core application processor, the ALLTEL Horizon
Banking System, Second National Bank took a quantum leap into the future.
The ALLTEL Horizon System is a feature-rich, state-of-the-art data processing
system specifically designed for banks with assets between $1 and 10 billion.
The IBM AS/400-based system offers Second National tremendous advantages,
including greater control and flexibility, cost efficiencies, and enhanced
reporting and analysis capabilities, and Year 2000 compliance.
The new system has reduced the overnight data processing cycle by 66%. In
addition, the ALLTELL Horizon System has dramatically improved Second National's
product development capabilities. The flexibility of the new software enables
the Bank to respond more quickly to changes within the marketplace--and at a
lower cost. Within the new processing environment, we are able to introduce or
modify products and services virtually overnight.
Because all applications within the core processing solution are interconnected,
the system has also significantly increased Second National's capabilities in
data gathering, reporting, and analysis. Our new database software has unlimited
potential to pull and combine data from any and all applications
instantaneously. The open architecture of the system also enables Second
National to retain various existing subsystems and will allow for the addition
of new technology modules that meet both Bank and customer needs.
WEB SITES
Second National Bank entered cyberspace in 1997 by opening two informational web
sites on the Internet.
The Bank's home page at www.secondnationalbank.com contains a complete
description of the Bank and all of our products and services, as well as job
listings and a financial calculator where loan payments and savings plans can be
estimated.
An Internet presence was also established for Second National's parent company,
Second Bancorp, Inc. Information on Second Bancorp that is of special interest
to the investor is now available through the web site of PR Newswire at
www.prnewswire.com.
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TRUST DIVISION
Second National Bank's commitment to innovation continued to be exemplified by
the Trust Division, which marked its eighth year of record earnings and asset
growth in 1997.
Second National was one of the first banks in the state of Ohio to market an
Institutional Trust Program, which offers our trust services--from investment
and pension services, to estate planning and probate administration--to the
customers of other financial institutions that do not offer their own trust
services. During 1997, a total of 10 financial institutions throughout Ohio
contracted with Second National and began utilizing our Institutional Trust
Program.
Second National's Trust Division continued to receive national recognition for
its investment returns. Nelson's Investment Manager Database ranked Second
National's Fixed Income Pension Trust as the best in the nation for the 1, 3, 5
and 10 year periods ending March 31, 1997. The Bank's Equity Fund was also cited
as one of the top performing money managers in Nelson Publication's World's Best
Money Managers. The fund was ranked 36th among 272 growth and value equity funds
for the quarter ending June 30, 1997.
COMMERCIAL LENDING
Second National Bank's Commercial Lending Division maintained its status as an
aggressive and innovative commercial lender in 1997. The Commercial Lending
Division remained a leader in U.S. Small Business Administration (SBA) lending,
extending 50 SBA loans worth $7.5 million. For fiscal year 1997, that volume
ranked Second National second among the top community bank SBA lenders and sixth
within the entire Cleveland district.
By specializing in SBA lending, Second National provides local businesses with
the products and services they need most. At the same time, Second National
sells the guaranteed portion of SBA loans, providing the Bank with an important
source of non-interest income.
RETAIL LENDING
With an increased emphasis on consumer lending, both real estate and other
consumer products have flourished at Second National.
A greater variety of products and outstanding service led to a record year in
mortgage loans--by year-end, outstanding balances of over $79 million were up 25
percent over 1996. Mortgage loan fee income and gains on secondary market sales
of more than $700,000 were 31.9 percent greater than 1996. With outstanding
balances of $17 million, home equity loans increased 46 percent over 1996.
OUTSTANDING CORPORATE PHILANTHROPIST
Second National Bank continued its positive impact on the communities it serves
by being actively involved and supportive of charitable, civic, and social
services organizations. The Bank was recognized for these efforts by the
National Society of Fund Raising Executives Eastern Chapter, which presented
Second National with the 1997 Outstanding Corporate Philanthropist Award.
Second National received this recognition for its exemplary record of civic
responsibility in support of philanthropic causes, our impact on non-profit
programs, and the way in which the Bank has encouraged creative and innovative
programs.
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SECOND BANCORP CHARITABLE FOUNDATION
To ensure the future of charitable giving at Second National, the Second Bancorp
Charitable Foundation was established in 1997. The foundation was funded with
over $800,000 in investment securities in anticipation of a costly change in the
federal tax code disallowing current market value tax deductions on charitable
donations. The move will enable the Bank to realize a tax savings over the next
decade while eliminating the need to expense annual charitable contributions to
the operating budget.
1998
In 1998, we will continue to focus on providing the best value to Second
National customers--a banking strategy we believe will yield the best return for
our shareholders. Well-trained employees, high-quality customer service, new
technologies, and expanded delivery systems are among our priorities for the
year.
SERVICE DELIVERY
To give our customers greater and more convenient access to Second National, we
plan to expand our branch network as well as offer additional alternative
delivery channels.
We will venture beyond our current five-county marketplace in 1998 by opening
new Second National locations within contiguous counties. With an established
customer base in Fairlawn growing westward, we have targeted the economically
vibrant area of Medina for a new mini-branch.
To accommodate the extraordinary growth of Second National's Akron and Poland
offices, we will expand both of these branches in 1998. With increased square
footage, these offices will provide additional specialty products and services
through a full complement of financial professionals.
ALTERNATIVE DELIVERY CHANNELS
For customers looking for ways to utilize Second National services without
visiting our "brick and mortar" offices, we will continue to expand our
alternative delivery channels. In 1998, we plan to add two important services
that will significantly enhance remote access to Second National: an interactive
voice response (IVR) system and a Call Center. With these new services, Second
National customers will be able to do virtually anything they can do in a
branch--all via the telephone.
INTERACTIVE VOICE RESPONSE SYSTEM
The interactive voice response (IVR) system will provide 24-hour automated
access, allowing our customers to retrieve basic account information and perform
monetary transactions using a touch-tone phone. In conjunction with a bill
payment module, the IVR will also allow customers to pay virtually any bill by
telephone, 24 hours a day.
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CALL CENTER
The second alternative delivery initiative of 1998 will be the conversion of the
Bank's Customer Information Center into a 24-hour telephone banking center. The
new Call Center will extend the sales and service efforts of our branch
employees by providing customers with telephone access to Second National
personal bankers during expanded hours.
The Call Center project will be carefully monitored and evaluated, allowing
Second National to modify the program based on customer utilization. Our
evaluation process will include benchmarking "outside the box" with non-bank
retailers that represent the best in their class for call centers.
As remote banking strategies become increasingly popular in the marketplace, we
will continue to monitor the preferences of Second National's specific customer
base, in addition to evaluating our ability to provide new applications
profitably.
PC-TO-PC BANKING
One specific channel we will extensively research in 1998 is PC-to-PC banking
for our retail customers. We plan to evaluate several options, including the
conversion of our static website into an interactive site, giving careful
consideration to Internet security and technology. We will also explore the
feasibility of migrating the interactive voice response (IVR) system from a
telephone to a personal computer environment. Other on-line banking options
Second National will review include proprietary personal financial systems, such
as Microsoft Money(R) and Intuit's Quicken(R), and the AutoLink(SM) cash
management module, which currently provides PC-to-PC banking to our corporate
customers.
PREPARING FOR THE 21ST CENTURY
With the turn of the century on the horizon, Second National Bank has committed
the resources and personnel required to manage the Bank's transition into the
21st century and to comply with Year 2000 requirements. Our Year 2000, or Y2K,
team is carefully evaluating the date change and its effect on Second National.
The group has developed an overall strategy including discovery, planning, and
implementation processes to manage the Bank's compliance program.
VALUE BANKING
To continually reinforce Second National's core values, Executive Management has
made a commitment to work one-on-one with department managers and branch
managers of the Bank to drive our customer service--and profitability --to new
levels. Under the guidance of our executive managers, Second National employees
will continue to incorporate the core values into their daily work routine,
while making individual contributions to sales and increased return on assets.
By combining these initiatives with an ongoing focus on our customers and their
financial needs, we expect to establish and maintain real value in all our
stakeholder relationships.
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Market Area.
The Bank's primary market area consists of Trumbull, Mahoning, Portage, Summit
and Ashtabula counties in the northeastern corner of Ohio, to the east and south
of the Cleveland metropolitan area. The market area's economy is heavily
influenced by the manufacturing sector with an emphasis on steel, auto
manufacturing and a variety of related and smaller industries. The area has
benefited from an extensive transportation system comprised mainly of railroad
and trucking systems.
Competition.
There is significant competition in the financial services industry in
northeastern Ohio among commercial banks. As a result of deregulation of the
financial services industry, the Company also competes with other providers of
financial services such as savings and loan associations, credit unions,
commercial finance companies, brokerage and securities firms, insurance
companies, commercial finance and leasing companies and the mutual fund
industry. Some of the Company's competitors, including certain regional bank
holding companies which have operations in the Company's market area, have
substantially greater resources than the Company, and as such, may have higher
lending limits and may offer other services not available through the Bank. The
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Company also faces significant competition, particularly with respect to
interest rates paid on deposit accounts, from well-capitalized local thrift
institutions. The Bank competes on the basis of rates of interest charged on
loans, the rates of interest paid on funds, the availability of services and
responsiveness to the needs of its customers.
Regulation.
The Company is a one bank holding company and is regulated by the Federal
Reserve Bank (the "FRB"). The Bank is a national bank and is regulated by the
Office of the Comptroller of the Currency (the "OCC"), as well as the Federal
Deposit Insurance Corporation (the "FDIC"). Dramatic changes have developed over
the past several years regarding minimum capital requirements for financial
institutions. A listing of the minimum requirements for capital and the
Company's capital position as of December 31, 1997 and 1996 are presented in
footnote 12 of Item 8; Financial Statements and Supplementary Data and is hereby
incorporated by reference.
The Company is subject to regulation under the Bank Holding Company Act of 1956,
as amended (the "Act"). The Act restricts the geographic and product range of
bank holding companies by circumscribing the types and locations of institutions
the holding companies own or acquire. Among the states where the Company may
acquire banks are Ohio and Pennsylvania. The Act also regulates transactions
between the Company and the Bank and generally prohibits tie-ins between credit
and other products and services.
The Bank is subject to regulation under the National Banking Act and is
periodically examined by OCC and is subject, as a member bank, to the rules and
regulations of the FRB. The Bank is an insured institution and member of the
Bank Insurance Fund ("BIF") and also has approximately $53 million in deposits
acquired through acquisitions of branches of savings and loan institutions that
are insured through the Savings Association Insurance Fund ("SAIF"). As such,
the Bank is also subject to regulation by the FDIC. Establishment of branches is
subject to approval of the OCC and geographic limits established by state law.
Ohio branch banking law permits a bank having its principal place of business in
the State of Ohio to establish branch offices in any county in Ohio without
geographic restrictions. A bank may also merge with any national or state
chartered bank located anywhere in the State of Ohio without geographic
restrictions.
Regulations governing the Company and its banking subsidiary change as Congress
and state legislatures respond to conditions affecting the industry and set new
policy objectives.
FIRREA
FIRREA restructures the regulation, supervision and deposit insurance of savings
and loan associations and federal savings banks whose deposits were formerly
insured by the Federal Savings and Loans Insurance Corporation ("FSLIC"). FSLIC
was replaced by the Savings Association Insurance Fund ("SAIF") administered by
the FDIC. A separate fund, the Bank Insurance Fund ("BIF"), which was
essentially a continuation of the FDIC's then existing fund, was established for
banks and state savings banks. An acquired thrift generally would be required to
continue its deposit insurance with the SAIF unless significant exit and
entrance fees were paid in connection with a conversion to BIF insurance.
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FDICIA
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
substantially revised the bank regulatory and funding provisions of the Federal
Deposit Insurance Act and several other federal banking statutes. Among other
things, FDICIA requires federal banking agencies to broaden the scope of
regulatory corrective action taken with respect to banks that do not meet
minimum capital requirements and to take such actions promptly in order to
minimize losses to the FDIC. FDICIA established five capital tiers: "well
capitalized"; "adequately capitalized"; "undercapitalized"; "significantly
capitalized"; and "critically undercapitalized" and imposes significant
restrictions on the operations of a depository institution that is not in either
of the first two of such categories. A depository institution's capital tier
will depend upon the relationship of its capital to various capital measures. A
depository institution will be deemed to be "well capitalized" if it
significantly exceeds the minimum level required by regulation for each relevant
capital measure, "adequately capitalized" if it meets each such measure,
"undercapitalized" if it is significantly below any such measure and "critically
undercapitalized" if it fails to meet any critical capital level set forth in
regulations. An institution may be deemed to be in a capitalization category
that is lower than is indicated by its actual capital position if it receives an
unsatisfactory examination rating or is deemed to be in an unsafe or unsound
condition or to be engaging in unsafe or unsound practices.
Under regulations adopted under these provisions, for an institution to be well
capitalized it must have a total risk-based capital ratio of at least 10%, a
Tier I risk-based capital ratio of at least 6% and a Tier I leverage ratio of at
least 5% and not be subject to any specific capital order or directive. For an
institution to be adequately capitalized, it must have a total risk-based
capital ratio of at least 8%, a Tier I risk-based capital ratio of at least 4%
and a Tier I leverage ratio of at least 4% (or in some cases 3%). Under the
regulations, an institution will be deemed to be undercapitalized if the bank
has a total risk-based capital ratio that is less than 8%, a Tier I risk-based
capital that is less than 4% or a Tier I leverage ratio of less than 4% (or in
some cases 3%). An institution will be deemed to be significantly
undercapitalized if the bank has a total risk-based capital ratio that is less
than 6%, a Tier I risk-based capital ratio that is less than 3%, or a leverage
ratio that is less than 3% and will be deemed to be critically undercapitalized
if it has a ratio of tangible equity to total assets that is equal to or less
than 2%.
FDICIA generally prohibits a depository institution from making a capital
distribution (including payment of dividends) or paying management fees to any
entity that controls the institution if it thereafter would be undercapitalized.
If an institution becomes undercapitalized, it will be generally restricted from
borrowing from the Federal Reserve, increasing its average total assets, making
any acquisitions, establishing any branches or engaging in any new line of
business. An undercapitalized institution must submit an acceptable capital
restoration plan to the appropriate federal banking agency, which plan must, in
the opinion of such agency, be based on realistic assumptions and be "likely to
succeed" in restoring the institution's capital. In connection with the approval
of such a plan, the holding company of the institution must guarantee that the
institution will comply with the plan, subject to a limitation of liability
equal to a portion of the institution's assets. If an undercapitalized
institution fails to submit an acceptable plan or fails to implement such a
plan, it will be treated as if it is significantly undercapitalized.
Under FDICIA, bank regulators are directed to require "significantly
undercapitalized" institutions, among other things, to restrict business
activities, raise capital through a sale of stock, merge with another
institution and/or take any other action which the agency determines would
better carry out the purposes of FDICIA.
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Within 90 days after an institution is determined to be "critically
undercapitalized", the appropriate federal banking agency must, in most cases,
appoint a receiver or conservator for the institution or take such other action
as the agency determines would better achieve the purposes of FDICIA. In
general, "critically undercapitalized" institutions will be prohibited from
paying principal or interest on their subordinated debt and will be subject to
other substantial restrictions.
Under FDICIA, an institution that is not well capitalized is generally
prohibited from accepting brokered deposits. Undercapitalized institutions are
prohibited from offering interest rates on deposits significantly higher than
prevailing rates.
The provisions of FDICIA governing capital regulations became effective on
December 19, 1992. FDICIA also directs that each federal banking agency
prescribe standards for depository institutions and depository institution
holding companies relating to internal controls, information systems, internal
audit systems, loan documentation, credit underwriting, interest rate exposure,
asset growth, a maximum ratio of classified assets to capital, a minimum ratio
of market value to book value for publicly traded shares (if feasible) and such
other standards as the agency deems appropriate.
FDICIA also contains a variety of other provisions that could affect the
operations of the Company, including new reporting requirements, regulatory
standards for real estate lending, "truth in savings" provisions, the
requirement that a depository institution give 90 days' prior notice to
customers and regulatory authorities before closing any branch, limitations on
credit exposure between banks, restrictions on loans to a bank's insiders and
guidelines governing regulatory examinations.
Pursuant to FDICIA, the FDIC has developed a transitional risk- based assessment
system, under which, beginning on January 1, 1993, the assessment rate for an
insured depository institution varied according to its level of risk. An
institution's risk category will depend upon whether the institution is well
capitalized, adequately capitalized or less than adequately capitalized and
whether it is assigned to Subgroup A, B or C. Subgroup A institutions are
financially sound institutions with few minor weaknesses; Subgroup B
institutions are institutions that demonstrate weaknesses which, if not
corrected, could result in significant deterioration; and Subgroup C
institutions are institutions for which there is a substantial probability that
the FDIC will suffer a loss in connection with the institution unless effective
action is taken to correct the areas of weakness. Beginning in 1996 and based on
its capital and supervisory subgroups, each BIF member institution will be
assigned an annual FDIC assessment rate per $100 of insured deposits varying
between 0.00% per annum (for well capitalized Subgroup A institutions) and 0.27%
per annum (for undercapitalized Subgroup C institutions). With the
recapitalization of the SAIF fund in 1996, the assessment rate for SAIF insured
deposits has decreased to an annual rate per $100 of insured deposits of 0.00%
to 0.27%. There are proposed significant changes to the insurance premium
structure that may be enacted through congressional legislation. The ultimate
effect of these changes cannot be ascertained until final regulations are
adopted.
Interstate Banking and Branching Legislation
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"IBBEA") authorized interstate acquisitions of banks and bank holding companies
without geographic constraint beginning September 29, 1995. Beginning June 1,
1997, the IBBEA also authorizes
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banks to merge with banks located in another state provided that neither state
has "opted out" of interstate branching between September 29, 1994 and May 31,
1997. States could also enact legislation permitting interstate merger
transactions prior to June 1, 1997. After acquiring interstate branches through
a merger, a bank may establish additional branches in that state at the same
locations as any bank involved in the merger could have established branches
under state and federal law. In addition, a bank may establish a de novo branch
in another state that expressly permits the establishment of such branches. A
bank that establishes a de novo interstate branch may thereafter establish
additional branches on the same basis as a bank that has established interstate
branches through a merger transaction.
If a state "opts out" of interstate branching, no bank from another state may
establish a branch in that state, whether through a merger of de novo
establishment. As of June 1, 1997, Pennsylvania, the state in closest proximity
to the Bank, has opted to permit interstate branching, creating the possibility
of branching into that state. To date, the Bank has taken no action to branch
into Pennsylvania or any other state, however the Bank may do so in the future.
Employees.
The number of full time equivalent employees of the Company as of December 31,
1997 was approximately 373. The Company considers its employee relations to be
good. None of the employees are covered by a collective bargaining agreement.
ITEM 2. PROPERTIES.
The Company's executive offices are located at the Bank's main office building
in Warren, Ohio, which is leased by the Bank under a long-term triple net lease
agreement with a term, including optional renewals, expiring on October 31,
2029. The Bank has the option to purchase the main office facility before two
optional renewal periods at the fair market value in existence at that time. The
Bank owns four of its branch locations, while the Bank's 22 other branch and
loan production office locations are leased under lease and sublease agreements
with remaining terms of 1 to 14 years. The Bank also has leases for record
retention and office space with remaining lease terms of two and eight years,
respectively.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to various pending and threatened lawsuits in which
claims for monetary damages are asserted in the ordinary course of business.
While any litigation involves an element of uncertainty, in the opinion of
management, liabilities, if any, arising from such litigation or threat thereof
will not have a material effect on the financial position, liquidity or results
of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no special meetings for shareholders since last year's annual
meeting.
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ITEM 4a. IDENTIFICATION OF EXECUTIVE OFFICERS.
The following table sets forth the names and ages and business experience for
the last five years of each of the executive officers of the Corporation. Each
executive officer of the Corporation is appointed by the Board of Directors on
an annual basis, and serves at the pleasure of the Board.
Name Age Position and Experience Year Appointed
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Alan G. Brant 65 Chairman and President of 1987
Second Bancorp, Inc. and
Chief Executive Officer of
The Second National Bank of
Warren.
David H. Dye 53 Senior Vice President of Second 1997
Bancorp, Inc. and Executive
Vice President and Chief Lending
Officer of The Second National Bank
of Warren. Prior to 1997, Regional
President of Star Bank, N.A.
Joseph D. Rusnak 57 Executive Vice President of 1996
Second Bancorp, Inc. and Vice
President of The Second
National Bank of Warren. Prior
to 1996, President of Horizon
Savings Bank and prior to that
Vice President of Society Bank.
Christopher Stanitz 49 Senior Vice President of 1992
Second Bancorp, Inc. and Vice
President of The Second
National Bank of Warren. Prior
to 1992, Associate Counsel of
Ameritrust, NA.
David L. Kellerman 40 Treasurer of Second Bancorp, 1987
Inc. and Senior Vice President and
Chief Financial Officer of The
Second National Bank of Warren.
William Hanshaw 45 Executive Officer of Second 1989
Bancorp, Inc. and Senior
Vice President of The Second
National Bank of Warren.
Diane C. Bastic 54 Executive Officer of Second 1985
Bancorp, Inc. and Senior
Vice President of The Second
National Bank of Warren.
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Darryl E. Mast 47 Executive Officer of Second 1986
Bancorp, Inc. and Senior Vice
President of The Second
National Bank of Warren.
Terry L. Myers 48 Executive Officer of Second 1986
Bancorp, Inc. and Senior Vice
President of The Second
National Bank of Warren.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
The Company's Common Stock trades on The Nasdaq National Market tier of The
Nasdaq Stock Market under the trading symbol SECD. As of March 13, 1998, the
number of shareholders of record of the Common Stock totaled 2,126. The detail
of stock prices and dividend payments are incorporated herein by reference to
Item 7; Management's Discussion and Analysis of Financial Condition and Results
of Operations. Dividend restrictions are detailed in footnote 12 of Item 8;
Financial Statements and Supplementary Data and is incorporated herein by
reference.
12
14
ITEM 6. SELECTED FINANCIAL DATA.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
This Management's discussion and analysis of financial condition and
results of operations should be read in conjunction with the
consolidated financial statements and accompanying footnotes
beginning on page 21.
SELECTED FINANCIAL DATA
Year ended December 31 1997 1996 1995 1994 1993
Results of Operations:
Interest income $ 68,247 $ 65,646 $ 62,544 $ 52,115 $ 46,603
Interest expense 33,496 31,785 30,803 22,064 19,340
------------------------------------------------------------------
Net interest income 34,751 33,861 31,741 30,051 27,263
Provision for loan losses 3,939 4,956 3,000 2,370 2,555
Other income 9,204 8,479 7,545 4,979 4,822
Other expense 28,591 26,276 26,026 23,627 21,381
------------------------------------------------------------------
Income before Federal income taxes 11,425 11,108 10,260 9,033 8,149
Federal tax expense 2,450 2,556 2,695 2,390 2,142
------------------------------------------------------------------
Net income $ 8,975 $ 8,552 $ 7,565 $ 6,643 $ 6,007
==================================================================
Per Common Share Data: (1)
Basic earnings $ 1.33 $ 1.33 $ 1.29 $ 1.11 $ .99
Diluted earnings 1.32 1.27 1.13 1.00 .91
Cash dividends .48 .44 .38 .32 .29
Book value, December 31 11.68 10.34 10.40 8.50 8.26
Market value, December 31 25.38 15.69 14.38 10.75 10.67
Weighted average shares outstanding (1)
Basic 6,749,435 6,070,666 5,056,242 4,998,408 4,976,278
Diluted 6,810,266 6,749,552 6,685,384 6,624,652 6,597,452
Shares outstanding at year-end (1) 6,800,263 6,697,174 5,124,082 5,018,632 4,977,807
Per Preferred Share Data:
Cash dividends n/a $ .75 $ 1.50 $ 1.50 $ 1.50
Market value, December 31 n/a n/a 31.50 23.75 27.00
Balance Sheet Data:
As of December 31:
Total assets $ 913,480 $ 867,279 $ 833,912 $ 787,189 $ 674,575
Loans, net 559,637 558,437 527,442 499,772 465,841
Deposits 703,266 669,397 657,851 615,763 554,497
Shareholders' equity 79,428 69,237 66,033 55,883 54,362
Averages:
Total assets 897,104 850,662 807,215 717,904 640,516
Earning assets 841,333 792,239 750,355 675,257 602,965
Loans 573,777 558,373 526,202 481,135 444,894
Deposits 669,678 663,544 637,453 580,012 532,896
Shareholders' equity 73,077 66,149 59,805 54,917 52,491
Ratios:
Return on average assets 1.00% 1.01% .94% .93% .94%
Return on average total
shareholders' equity 12.28 12.93 12.65 12.10 11.44
Return on average common
shareholders' equity 12.28 14.01 13.92 13.35 12.56
Net interest margin 4.34 4.47 4.40 4.63 4.72
Net overhead ratio 2.38 2.30 2.55 2.76 2.76
Efficiency ratio 63.31 60.55 65.21 65.25 64.41
Dividend pay-out 36.19 34.78 29.67 28.77 29.62
Average loans to average deposits 85.68 84.15 82.55 82.95 83.49
Allowance for loan losses as a percent of loans 1.21 1.29 1.26 1.21 1.14
Net charge-offs as a percent of average loans .76 .79 .45 .34 .34
Non-performing loans to total loans .97 1.58 .78 1.09 .95
Allowance for loans losses to
non-performing loans 125.20 81.63 162.09 110.86 119.88
Tier I leverage ratio 8.22 7.75 7.39 7.48 8.03
<FN>
(1) Amounts have been retroactively restated for the two-for-one
stock split, effective May 1, 1997 and the three-for-two stock
split, effective May 1, 1995.
13
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net income for 1997 was a record $8,975, an increase of 5% over the
net income reported for 1996. Net income for 1996 was $8,552 and was
13% greater than net income reported in 1995 of $7,565. Over the past
four years, net income growth has averaged 11% annually. The
Corporation's return on average assets ("ROA") was 1.00%, 1.01% and
.94% for 1997, 1996 and 1995, respectively. The total shareholders'
return on average equity ("ROE") was also reduced slightly in 1997 at
12.28% as compared to 12.93% in 1996 and 12.65% in 1995. An increase
in common stock of nearly $1.2 million was generated through the
dividend reinvestment program in 1997, thereby increasing the
shareholders' equity balances and contributing to the reduced level
of ROE.
Basic earnings per common share was $1.33 per share in 1997, the same
level achieved in 1996. Basic earnings per share was $1.29 in 1995.
Diluted earnings per share, which takes into effect the dilutive
impact of the preferred stock which was present through mid-1996,
were $1.32 per share in 1997 and represents a 4% increase from the
prior year. Diluted earnings per share were $1.27 and 1.13 in 1996
and 1995, respectively. The Corporation declared a two-for-one stock
split for the common stock effective May 1, 1997. The Corporation's
common stock, trading under the NASDAQ symbol of SECD, has reflected
the improved earnings performance of the Corporation, increasing to a
split adjusted $25.38 per share as of December 31, 1997 from $15.69
per share at December 31, 1996. This price represents a 62% increase
over the closing price for 1996 and also represents a price of 217%
of book value. Dividends declared in 1997 totaled $.48 per share.
This represents an increase of 9% over 1996, when dividends declared
were $.44 per share. This also continues the Corporation's record of
increased dividends for each of the 10 years since the holding
company's inception in 1987.
Revenue continues to be provided primarily from interest and fees on
loans which totaled $51,908, $51,361 and $49,113 in 1997, 1996 and
1995, respectively. This represents 67.0%, 69.3% and 70.1% of total
revenues for those years. Interest income is also a major source of
revenue, contributing 20.3%, 18.9% and 18.3% of revenues in 1997,
1996 and 1995, respectively.
- -------------------------------------------------------------------------------
NET INTEREST INCOME
The Corporation was able to increase the net interest income in 1997
through the growth in earning assets achieved during the year. Net
interest income increased by 2.6% from $33,861 in 1996 to $34,751 in
1997. Average earning assets increased by 6% to $841,333 in 1997 over
1996. Similarly, net interest income increased by 6.7% from 1995 to
1996 while average earning assets increased by 5.6%. The
Corporation's net interest margin declined in 1997 to 4.34% from
4.47% in 1996. The Corporation continues to face tightening pressures
on the net interest margin. A flattening yield curve, slower overall
loan growth and increased competition over deposits have contributed
to lower the margin during the past year. Late in 1996, the Bank
substantially reduced the amount of loans made via its indirect
automobile lending program. Typically, only "A" rated loans are now
being accepted. Previously, all quality ranges from "A" to "D" were
accepted and priced according to risk assumed. The outstanding
balance of indirect automobile loans declined from $156 million as of
December 31, 1996 to $118 million as of December 31, 1997. Otherwise,
loan balances have increased by 11% during 1997 to $451 million at
year-end. Net loan balances represented 61%, 64% and 63% of assets at
December 31, 1997, 1996 and 1995, respectively. Deposits averaged
$670 million in 1997, representing a 1% increase over 1996. Funding
growth was concentrated in time deposits, retail repurchase
agreements and Federal Home Loan Bank advances. The growth in these
higher cost categories generated an increase in the average funding
cost from 4.52% to 4.56% in 1997.
The relationship between net interest income, FTE net interest
income, earning assets and net interest margin for the past three
years follows:
1997 1996 1995
Net interest income - per financial statements $ 34,751 $ 33,861 $ 31,741
Tax equivalent adjustment 1,798 1,517 1,260
---------------------------------
Net interest income - FTE $ 36,549 $ 35,378 $ 33,001
=================================
Average earning assets $841,333 $792,239 $750,355
Net interest margin 4.34% 4.47% 4.40%
Net interest income can be analyzed through the use of the Yields
Analysis table. The table shows a three-year comparison of the
average balance of interest earning assets and interest bearing
liabilities along with interest and yields associated with them.
14
16
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
YIELDS ANALYSIS
Year Ended December 31
1997 1996 1995
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
ASSETS
Interest earning assets:
Taxable loans (1) (3) $560,630 $51,272 9.15% $544,797 $50,621 9.29% $512,166 $48,303 9.43%
Tax-exempt loans (2) 13,147 964 7.33 13,576 1,121 8.26 14,036 1,227 8.74
Taxable securities 199,137 12,869 6.46 184,433 11,789 6.39 182,291 11,167 6.13
Tax-exempt securities 57,228 4,324 7.56 44,000 3,341 7.59 31,232 2,478 7.93
Federal funds sold 11,191 616 5.50 5,433 291 5.36 10,630 629 5.92
----------------------------------------------------------------------------------------
Total interest earning assets 841,333 70,045 8.33 792,239 67,163 8.48 750,355 63,804 8.50
Non-interest earning assets:
Cash and demand balances
due from banks 26,092 27,412 27,550
Properties and equipment 9,676 7,851 6,064
Accrued interest receivable 5,490 4,377 4,423
Goodwill and intangible assets 3,322 4,134 5,069
Other assets 18,464 22,041 20,105
Less: Reserve for loan losses (7,273) (7,392) (6,351)
----------------------------------------------------------------------------------------
TOTAL $897,104 $850,662 $807,215
=========================================================================================
LIABILITIES AND SHARHOLDERS'
EQUITY
Interest bearing liabilities:
Demand deposits
- interest bearing $ 63,160 1,135 1.80 $ 68,371 1,741 2.55 $ 63,713 1,600 2.51
Savings deposits 154,375 4,295 2.78 160,774 4,307 2.68 178,543 5,452 3.05
Time deposits 368,933 20,617 5.59 359,170 20,295 5.65 322,011 18,363 5.70
Federal funds purchased and
securities sold under
agreements to repurchase 110,498 5,175 4.68 89,601 3,917 4.37 89,026 4,307 4.84
Note payable 3,647 276 7.57 5,000 371 7.42 5,000 434 8.68
Other borrowed funds 2,846 157 5.52 2,732 144 5.27 3,220 181 5.62
Federal Home Loan Bank
advances 31,374 1,841 5.87 17,458 1,010 5.79 7,586 466 6.14
----------------------------------------------------------------------------------------
Total interest bearing
liabilities 734,833 33,496 4.56 703,106 31,785 4.52 669,099 30,803 4.60
Non-interest bearing
liabilities:
Demand deposits 83,210 75,229 73,186
Accrued expenses and
other liabilities 5,984 6,178 5,125
----------------------------------------------------------------------------------------
Other liabilities 89,194 81,407 78,311
Shareholders' equity 73,077 66,149 59,805
----------------------------------------------------------------------------------------
TOTAL $897,104 $850,662 $807,215
=========================================================================================
Net interest earnings (FTE) 36,549 35,378 33,001
Taxable equivalent adjustment 1,798 1,517 1,260
----------------------------------------------------------------------------------------
Net interest income
(per financial statements) $34,751 $33,861 $31,741
=========================================================================================
Net yield on interest earning
assets 4.34% 4.47% 4.40%
=========================================================================================
<FN>
(1) For purposes of these computations, non-accruing loans are
included in the daily average loan amounts outstanding.
(2) The tax-exempt income and yields are shown on a tax equivalent
basis using the 34% marginal Federal tax rates in effect during
the three years.
(3) Loan fees are included in the interest reported for loans. Those
fees amounted to $2,538 in 1997, $2,936 in 1996, and $2,610 in
1995.
15
17
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
You can further analyze the change in net interest income by
separating the volume and rate impact of the change. The following
table details the breakdown of the major categories affecting the
change:
1997 COMPARED TO 1996 1996 COMPARED TO 1995
RATE / VOLUME ANALYSIS (1) DUE TO CHANGE IN DUE TO CHANGE IN
VOLUME RATE NET VOLUME RATE NET
Increase (decrease) in FTE interest
income:
Taxable loans $1,471 $(820) $ 651 $3,077 $ (759) $2,318
Tax-exempt loans (35) (122) (157) (40) (66) (106)
Taxable securities 940 140 1,080 131 491 622
Tax-exempt securities 1,004 (21) 983 1,013 (150) 863
Federal funds sold 308 17 325 (308) (30) (338)
--------------------------------------------------------------------------
Total interest bearing assets $3,688 $(806) $2,882 $3,873 $ (514) $3,359
==========================================================================
Interest bearing liabilities:
Demand deposits-
interest bearing $ (133) $(473) $(606) $ 117 $ 24 $ 141
Savings deposits (171) 159 (12) (543) (602) (1,145)
Time deposits 552 (230) 322 2,119 (187) 1,932
Federal funds purchased and
securities sold under
agreements to repurchase 914 344 1,258 28 (418) (390)
Note payable (100) 5 (95) 0 (63) (63)
Other borrowed funds 6 7 13 (27) (10) (37)
Federal Home Loan Bank advances 805 26 831 606 (62) 544
---------------------------------------------------------------------------
Total interest bearing liabilities $1,873 $(162) $1,711 $2,300 $(1,318) $ 982
============================================================================
Total effect on net interest income $1,815 $(644) $1,171 $1,573 $ 804 $2,377
============================================================================
(1) The change in interest due to both rate and volume has been
allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each.
- --------------------------------------------------------------------------------
PROVISION FOR LOAN LOSSES
The provision for loan losses totaled $3,939 in 1997, or .69% of
average loans, slightly higher than the average level of .64% over
the past five years. The provision for loan losses was $4,956 in
1996, $3,000 in 1995, $2,370 in 1994 and $2,555 in 1993. The increase
in 1997 can be attributed to higher than historically normal levels
of net charge-offs for the commercial loan portfolio. Net charge-offs
as a percent of average commercial loans were .76% in 1997 and .66%
in 1996. The average net charge-off level for commercial loans from
1993 to 1995 was .15%. Consumer loan net charge-offs were lower in
1997 at 1.04% of average consumer loans as the Bank de-emphasized the
indirect lending program with area automobile dealers, strictly
limiting the amount of new lower quality loans.
- --------------------------------------------------------------------------------
NON-INTEREST INCOME
Non-interest income totaled $9,204 in 1997, which represented an 8.5%
increase over 1996. Service charges on deposit accounts improved by
12.5% to $3,021 in 1997. The increase is attributable to the increase
in revenue from ATM services provided and improvements on the
collection of return check and overdraft fees. Service charges on
deposits had increased 11.6% from 1995 to 1996. Trust fee income
totaled $2,562 in 1997, a 9.7% improvement over the prior year. The
revenue increase was partly attributable to new trust relationships
as well as increases in the market value of assets under management.
Trust fee income was $2,335 in 1996 and $2,227 in 1995. Other fee
income increased by 1% during 1997 and included $1,210 in combined
gains from the sale of mortgages and Small Business Administration
("SBA") loans. Other income had increased by 32% the prior year
through the combination of earnings from secondary mortgage and SBA
sale activities, sales of annuities and mutual funds and fees earned
through the successful payoff of commercial loans.
Included in non-interest income over the past three years were
pre-tax gains on the sale of securities. During 1997, the Corporation
established a charitable foundation to carry on the Corporation's
many charitable and civic activities. The gain realized on the
appreciated stock donated to the foundation was $352, which
represented a significant portion of the total gains realized in 1997
of $595. On November 15, 1995, the Financial Accounting Standards
Board (FASB) staff issued a special report, "A Guide to
Implementation of Statement No. 115 on Accounting for Certain
Investments in Debt and Equity Securities." In accordance with the
provisions of the special report, the Bank reclassified all debt
securities as available-for-sale. Since the reclassification, the
Corporation adjusts the structure of the security portfolio from time
to time to adjust to various market conditions. The adjustments
generated $462 and $634 in 1996 and 1995, respectively.
16
18
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
NON-INTEREST EXPENSE
The Corporation continues to emphasize expense control and to be
efficient in its utilization of resources to manage assets.
Non-interest expenses as a percentage of average assets were 3.19% in
1997 compared to 3.09% on 1996 and 3.22% in 1995. Excluding the
non-recurring charge to operations for the donation of $824 of stock
to the charitable foundation, the ratio would have been 3.10% in
1997. The table below details the percentage change in each
non-interest expense category over the past three years:
PERCENTAGE CHANGE
1997 OVER 1996 1996 OVER 1995
Salaries and benefits 7% 8%
Net occupancy 3 2
Equipment 34 15
Professional services 13 (9)
Assessment on deposits and other taxes 7 (54)
Amortization of goodwill and other intangibles (13) (14)
Other expenses 12 7
Equipment expense increased by 34% in 1997 due primarily to the cost
inherent in the conversion of the core processing system from a third
party provider to an in-house operating environment. Professional
service costs increased in 1997 as the Corporation continued to
outsource various functions that would not be cost-effective to
manage in-house. Excluding the one-time charge for donating stock to
the charitable foundation, other expenses would have actually
decreased by $90, or 1.5%.
- ------------------------------------------------------------------------------
INCOME TAXES
The provision for income taxes was $2,450, $2,556, and $2,695 in
1997, 1996, and 1995, respectively. The effective tax rate for the
Corporation was 21.4%, 23.0%, and 26.3% during the same periods. The
reduction in the effective tax rate in 1997 was due to the
continuation of the accumulation of tax-exempt securities and the
realization of investment tax credits through the Bank's
participation in low-income housing projects.
- -------------------------------------------------------------------------------
BALANCE SHEET
The average asset growth rate has averaged 9% over the past four
years. The 1997 growth rate in average assets was 5.5%. The slower
growth rate is attributable to both a lack of acquisitions during the
past three years and the planned de-emphasis of the indirect
automobile lending program. Also as an industry, banks are
experiencing slower deposit growth rates due to increased competition
from non-traditional alternatives, especially mutual funds. Deposit
balances finished the year totaling in excess of $700 million,
representing an increase of 5% from the previous year-end. Deposits
grew 2% from December 31, 1995 to December 31, 1996.
- -------------------------------------------------------------------------------
EARNING ASSETS
SECURITIES:
The securities portfolio of the Corporation is used to provide an
adequate rate of return to the Corporation along with appropriate
levels of liquidity, and as a tool for efficient tax management and
interest rate risk management. The accounting treatment for the
securities portfolio is determined by the Corporation's intent
regarding particular security holdings. Securities held-to-maturity
are purchased with the intent and ability to hold them to maturity
and are, therefore, carried at amortized cost. With the adoption of
SFAS No. 115 on January 1, 1994, certain securities were determined
to be available-for-sale and transferred from the held-to-maturity
category. On November 15, 1995, the FASB staff, through its issuance
of a special report involving SFAS No. 115, declared certain
provisions permitting additional reclassifications of securities
prior to December 31, 1995. On November 30, 1995, the Corporation, in
accordance with the provisions of the special report, reclassified
all debt securities as available-for-sale.
Subsequent to the transfer, securities were purchased to satisfy
yield enhancement, liquidity, interest rate risk management, and
pledging needs. Purchases in longer maturities that provided yield
enhancement included purchases of tax-exempt securities which provide
the additional benefit of tax reduction. Prior to November 30, 1995,
the Corporation's strategy was to place into available-for-sale,
securities with a shorter average maturity structure of approximately
2 years to provide for liquidity and flexibility in interest rate
risk management. Securities determined to meet the held-to-maturity
criteria were purchased with a longer average maturity structure of 4
to 5 years and an emphasis on yield enhancement.
17
19
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
The securities portfolio totaled $280,010 as of December 31, 1997.
That balance represents a 21% increase over the prior year-end. The
December 31, 1996 balance of $231,324 was 2% less than the prior
year-end. Since average asset growth for 1997 and 1996 was in excess
of 5% for both years, the growth in securities had an inverse
relationship to relative strength of loan growth over those same two
years. Average loan growth was less than 3% in 1997, while in 1996
average loans grew by 6%. The growth in securities in 1997 was spread
amongst all categories as the stated objectives were achieved. During
1996, tax-exempt securities and mortgage-backed securities increased
by 49% and 12%, respectively while U.S. Treasury government agency
securities decreased by 28%.
The average yield on the portfolio increased from 6.5% as of December
31, 1995 to 6.7% on December 31, 1996 to 6.8% at the end of 1997. The
Corporation accomplished the improvement in yield in 1997 while
overall interest rates were moving downward. Also during the past
year, the Corporation realized $595 in net gains on the sale of
securities. In 1996 and 1995, net security gains totaled $462 and
$634, respectively. As interest rates have fluctuated over the past
two years, the Corporation's net unrealized gain or loss position for
the portfolio has fluctuated also. The position has moved from an
unrealized gain of $3,407 as of December 31, 1995 to an unrealized
loss of $37 as of December 31, 1996 to an unrealized gain position of
$4,569 as of the latest year-end.
Summary yield and maturity information regarding the securities
portfolios on December 31 follows. Yields are calculated on a fully
taxable equivalent basis using the marginal Federal income tax rate
of 34% for 1997.
BOOK VALUE
1997 1996 1995
AVAILABLE- 1997 AVAILABLE- AVAILABLE-
FOR-SALE YIELD FOR-SALE FOR-SALE
U.S. Treasury and other U.S. Government agencies
and corporations:
Under 1 year $ 40,270 5.7% $ 23,912 $ 32,028
1 to 5 years 36,478 6.4 35,689 48,541
5 to 10 years 16,299 7.1 16,926 21,183
Over 10 years 0 0.0 0 3,971
---------------------------------------------------------
Total 93,047 6.2 76,527 105,723
Obligations of states and political subdivisions:
Under 1 year 2,686 8.1 3,126 3,535
1 to 5 years 20,905 8.0 13,348 11,551
5 to 10 years 32,631 7.6 28,881 16,091
Over 10 years 6,809 7.4 6,395 3,503
---------------------------------------------------------
Total 63,031 7.7 51,750 34,680
Corporate:
Under 1 year 0 0.0 1,002 1,017
1 to 5 years 10,288 6.4 0 6,013
5 to 10 years 0 0.0 0 0
Over 10 years 0 0.0 0 0
---------------------------------------------------------
Total 10,288 6.4 1,002 7,030
Mortgage-backed securities 106,334 6.9 95,554 85,546
Equity securities 7,310 7.1 6,491 3,555
---------------------------------------------------------
$280,010 6.8% $231,324 $236,534
=========================================================
Mortgage-backed securities have various stated maturities through
September 2027. The estimated weighted-average maturity of this
segment of the portfolio is 4.6 years.
18
20
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
LOANS:
Listed below is the Corporation's loan distribution at the end of each
of the last 5 years:
1997 1996 1995 1994 1993
Commercial $306,746 $297,347 $269,248 $238,053 $217,529
Consumer 180,588 205,409 195,752 202,343 176,409
Real estate mortgage 79,158 62,981 69,190 65,502 54,154
Loans held-for-sale 0 0 0 0 23,141
-----------------------------------------------------------------------
Balance December 31 $566,492 $565,737 $534,190 $505,898 $471,233
======================================================================
The Corporation continues to emphasize growth in commercial balances
through its calling program targeting medium size companies.
Commercial loan balances have increased by 41% since December 31,
1993, closing the current year at $307 million. Commercial loans have
grown by 3%, 10% and 13% in 1997, 1996 and 1995, respectively.
An analysis of maturity and interest rate sensitivity of commercial
loans as of December 31, 1997 follows:
ONE YEAR ONE TO OVER
OR LESS FIVE YEARS FIVE YEARS TOTAL
Fixed rate $16,756 $33,267 $ 82,476 $132,499
Variable rate 60,643 32,246 81,358 174,247
-------------------------------------------------------
Total commercial loans $77,399 $65,513 $163,834 $306,746
=======================================================
The Bank de-emphasized its indirect lending program with automobile
dealers within the Bank's primary market areas in 1996, choosing to
permit more funds to be available to allow for commercial and real
estate loan growth. In 1996, the Bank shifted its focus on indirect
lending, strictly limiting the acquisition of lower-quality "C" and
"D" type paper. Prior to that, the Bank accepted a higher volume of
lower-quality paper utilizing a tiered pricing system designed to
compensate the Bank for the higher risk associated with the loans. The
volume of direct consumer lending through the retail branch system has
increased from approximately 17% of total consumer production in 1995
to 22% in 1996 to 45% in 1997. The Bank is still active in generating
loans from automobile dealers within the Bank's five-county market
area; however, future growth is targeted in higher-quality loans. The
Bank had outstanding $118 million and $156 million in indirect
automobile loans at the end of 1997 and 1996, respectively. The
charge-off and accounting policy regarding indirect automobile loans
does not differ from the policies discussed in Note 1.
With the adoption of SFAS No. 122, "Accounting for Mortgage Servicing
Rights" in 1995, the Corporation was required to recognize as
separate assets the value of mortgage servicing rights, whether the
rights are acquired through loan origination activities or through
purchase activities, virtually eliminating the opportunity to build
a servicing portfolio that would generate a strong source of
non-interest income in years of either strong or weak originations.
The adoption of the standard prompted the Corporation to introduce a
servicing released rate for purchasers that was lower than the normal
rate offered for the service-retained product. The Corporation
emphasizes real estate lending through its branch network, reaching
a broad range of customers. The Corporation has benefited from this
approach along with the use of mortgage loan originators and
correspondent lender relationships to originate $66 million in
mortgages originated in 1997 versus $44.5 million in 1996 and $34
million in 1995. Loans sold into the secondary market totaled $38
million in 1997, $38 million in 1996 and $18 million in 1995
generating net revenues of $712 in 1997, $519 in 1996 and $327 in
1995. Generally, the loans sold into the secondary mortgage market
make funds available for reuse in mortgage or other lending
activities, generate a net gain (including origination fee income)
from the sale, limit the interest rate risk caused by holding
long-term, fixed-rate loans and build a portfolio of serviced loans
which generate fee income for the Corporation. The serviced portfolio
of mortgages totaled $39.2 and $44.6 million as of December 31, 1997
and 1996, respectively.
The Corporation is also generating an increasing volume of Small
Business Administration ("SBA") loans. Of the SBA loans originated in
1997, $4.5 million of the guaranteed portions of the loans were sold.
The sales generated $498 in net revenues, including $143 in revenues
from the value of the servicing retained. The amount of SBA loans
being serviced by the Corporation totaled approximately $7.7 million
and $3.4 million at December 31, 1997 and 1996, respectively.
The Corporation's loans are granted to customers within the immediate
trade area of the Corporation. The mix is diverse, covering a wide
range of borrowers. The Corporation monitors and controls
concentrations within a particular industry or segment. As of December
31, 1997, the Corporation had a concentration in commercial real
estate loans totaling approximately $206 million, approximately 69% of
which were owner-occupied businesses, including medical office
buildings, retail and fast-food restaurants, and automobile
dealerships within the Corporation's market area.
19
21
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
ASSET QUALITY
The reserve for loan losses is analyzed in the table below:
Year Ended December 31 1997 1996 1995 1994 1993
Balance at January 1 $7,300 $6,748 $6,126 $5,392 $4,350
Charge-offs:
Commercial 2,413 2,051 775 535 563
Real estate 0 1 5 7 9
Consumer 2,725 3,128 2,220 1,712 1,366
--------------------------------------------------------------------
5,138 5,180 3,000 2,254 1,938
Recoveries:
Commercial 108 155 312 310 217
Real estate 0 0 0 14 3
Consumer 646 621 310 294 205
--------------------------------------------------------------------
754 776 622 618 425
--------------------------------------------------------------------
Net charge-offs 4,384 4,404 2,378 1,636 1,513
Additions:
Charged to operations 3,939 4,956 3,000 2,370 2,555
--------------------------------------------------------------------
Balance at December 31 $6,855 $7,300 $6,748 $6,126 $5,392
====================================================================
Reserve for loan losses as a percentage
of year end loans 1.21% 1.29% 1.26% 1.21% 1.14%
Reserve for loan losses as a percentage
of non-performing assets 125% 82% 161% 111% 120%
Net charge-offs as a percent of average loans by major loan category
are shown below:
Year Ended December 31 1997 1996 1995 1994 1993
Commercial .76% .66% .18% .10% .18%
Real estate mortgage .00 .00 .01 (.01) .01
Consumer 1.04 1.27 .95 .72 .60
Total net charge-offs to average loans .76 .79 .45 .34 .34
The balance of the reserve for loan losses has increased steadily from
1993 to 1996 and finished 1997 slightly lower at $6,855. Total
charge-offs exceeded $4 million for the second consecutive year
contributing to the reduction in the reserve balance. Losses on the
consumer portfolio were reduced in 1997 as the indirect automobile
lending program was de-emphasized. Commercial loan net charge-offs
have averaged $2.1 million over the past two years after averaging
only $345 from 1993 to 1995. Concurrently, the coverage ratio of the
loan loss reserve balance to non-performing loans improved from 82% at
the end of 1996 to 125% at the end of 1997. Contributing to the
ratio's improvement was the reclassification of $2.4 million from
loans to other assets. During 1997, one of the Bank's borrowers whose
loan balance was included in non-performing loans as of December 31,
1996 settled all their obligations with the Bank by placing
approximately $2.7 million in a third party trust. An unsecured
creditor, who is subordinate to the Bank, has challenged the Bank's
claims on these funds in bankruptcy court. While there can be no
assurance as to the ultimate collectibility of this receivable, in
consultation with outside counsel, the Bank believes it will
ultimately receive an amount from the trust that would not result in a
material effect on the financial position or results of operations.
20
22
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
The following presents a breakdown of the allocation of the loan loss
allowance by loan category for each of the last five years:
DECEMBER 31
Loan Category 1997 1996 1995 1994 1993
Commercial $4,103 60% $4,720 65% $3,933 58% $3,578 58% $2,984 55%
Consumer 2,557 37 2,570 35 2,777 41 2,368 39 2,271 42
Real Estate 195 3 10 0 38 1 180 3 137 3
-------------------------------------------------------------------------------------
$6,855 100% $7,300 100% $6,748 100% $6,126 100% $5,392 100%
=====================================================================================
The determination of the reserve for loan losses is based on
Management's evaluation of the potential losses in the loan portfolio
considering, among other relevant factors, repayment status,
borrowers' ability to repay, collateral, and current and foreseeable
economic conditions. The Bank utilizes its internal loan gradings for
commercial loans in conjunction with historical loss experience for
loans of each grade level and current economic trends as parts of its
analysis in determining the adequacy of its reserve for loan losses.
Below is a table listing the non-accrual, past due and restructured
loans at the end of the last five years:
DECEMBER 31
1997 1996 1995 1994 1993
Non-accrual loans $4,492 $6,809 $2,673 $3,412 $2,984
Past due loans 970 1,963 1,465 2,081 1,513
Restructured loans 13 171 25 33 1
-------------------------------------------------------------------
$5,475 $8,943 $4,163 $5,526 $4,498
--------------------------------------------------------------------
Percent of loans at year end .97% 1.58% .78% 1.09% .95%
Other real estate owned $0 $0 $27 $116 $557
Loans 30 to 89 days past due, excluding non-accrual and restructured
loans included in the table above, amounted to $7,258, or 1.28% of
outstanding loans, as of December 31, 1997, as compared to $10,039,
or 1.78% of loans on December 31, 1996. Loans then current where some
concerns existed as to ability of the borrower to comply with loan
repayment terms approximated $33,258 at December 31, 1997 and $20,263
on December 31, 1996. Such loans have been and are being closely
monitored by Management.
Further discussion on loan quality and credit risk are presented in
Note 1f, 6 and 19 of Item 8; Financial Statements and Supplementary
Data and are incorporated herein by reference.
21
23
- -------------------------------------------------------------------------------
FUNDING SOURCES
DEPOSITS:
The average amounts of deposits are summarized below:
1997 1996 1995
Demand deposits - non-interest bearing $ 83,210 $ 75,229 $ 73,186
Demand deposits - interest bearing 63,160 68,371 63,713
Savings deposits 154,375 160,774 178,543
Time deposits 368,933 359,170 322,011
-----------------------------------------
$669,678 $663,544 $637,453
=========================================
Average deposits increased by 1% in 1997 with average non-interest
bearing demand deposits increasing by 11% and average time deposits
increasing by 3%. Non-interest bearing demand deposits increased
through the introduction of a "totally free" checking product along
with increased balances from corporate customers. In 1996, deposit
growth was concentrated primarily in time deposit balances, which
increased by nearly 12%. Savings deposits declined in both 1997 and
1996 as customers chose to seek higher yielding alternatives.
22
24
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
On December 31, 1997 time deposits over $100 totaled $67,295, an
increase of 8% from the previous year-end total of $62,235. The Bank
continues to maintain strong relationships with the various public
entities centered in the primary markets of the Bank. Time deposits
over $100 average approximately $54 million in 1997 and $59 million
in 1996. The 1997 year-end balance represents 10% of total deposits
compared to 9% of deposits as of the previous year-end. The maturity
schedule for time deposits over $100 as of December 31 is given in
the table below:
1997 1996
Maturing in:
3 months or less $27,234 $36,748
3 to 6 months 22,450 16,697
6 to 12 months 14,423 3,756
Over 12 months 3,188 5,034
------------------------
$67,295 $62,235
========================
OTHER SOURCES OF FUNDS:
The repurchase agreement program provides a sweep feature on the
customer's primary business account along with competitive market
rates of interest for their excess funds. The average balance of these
accounts was $106 million during 1997, which represents an increase of
23% over the average balance of $86 million in 1996. The success of
this product reflects the strong emphasis the Bank places on offering
competitive products coupled with personalized service to the small to
mid-size businesses operating in the Bank's various markets.
The Corporation also has available to it unsecured lines of credit
with correspondent banks totaling $15 million. The lines of credit
mature in 1998 and bear interest at a floating rate based on several
indices. There were no outstanding borrowings under these lines as of
December 31, 1997. The Corporation had $5 million in outstanding
borrowings at December 31, 1996.
The Corporation also has access to federal tax deposits on a daily
basis. After being deposited by customers, the tax deposits are held
at the Corporation up to a self-imposed limit of $6 million until they
are drawn upon by the federal government. The balance of these funds
was $3,492 and $3,989 as of December 31, 1997 and 1996, respectively.
The Corporation occasionally uses federal funds purchased from other
financial institutions as a source of short-term funding. The
Corporation had no federal funds purchased as of December 31, 1996 or
1995.
The Bank also is a member of the Federal Home Loan Bank ("FHLB")
system and utilizes the various advance programs offered by the FHLB.
The funds are drawn from the FHLB for various terms through 2009 and
are utilized to provide long-term funding to offset the interest rate
risk inherent with holding long-term, fixed-rate mortgages. The
balances of these advances were $9,864 and $26,557 as of December 31,
1997 and 1996, respectively.
- -------------------------------------------------------------------------------
CAPITAL
The shareholders' equity increased to $79,428 at December 31, 1997
from $69,237 a year earlier. The increase was primarily attributed to
the earnings retained this year after common stock dividend payments.
The impact of the change in unrealized market value adjustment on
securities available-for-sale, net of tax (SFAS No. 115 adjustment)
resulted in a net unrealized gain position of $3,016 at December 31,
1997 versus a net unrealized loss position of $24 at December 31,
1996. The SFAS 115 adjustment component in shareholders' equity at
the end of 1995 was a net gain of $2,248. The Corporation also
increased common stock by $1,183 through the dividend reinvestment
program. Shareholders' may invest cash dividends and voluntary cash
payments in additional shares at a 5% discount and without payment of
brokerage commissions or service charges. Common stock was also
increased by the exercise of $717 of options. In 1996, common stock
increased by $271 and $276 due to dividend reinvestment and option
exercise activities. In 1997, $474 of treasury stock was repurchased,
while in 1996 the repurchase totaled $319. On May 7, 1996 the Board
of Directors authorized the Corporation to repurchase up to 140,000
shares of its common stock. As of December 31, 1997, the Corporation
had repurchased 50,400 shares. The repurchase of any more than
140,000 shares of stock must first be approved by creditors. In 1995,
shareholders' equity increased by $10,150 and primarily reflected
earnings retained during the year along with the increase associated
with the SFAS 115 adjustment. Effective June 25, 1996, the
Corporation called for the redemption of all the outstanding shares
of the Series A $1.50 preferred stock. Virtually all preferred
stockholders exercised their conversion rights prior to the
redemption date. The net effect was a transfer of approximately $12.7
million in capital from preferred stock to common stock. In 1995,
certain preferred stockholders exercised their conversion rights,
resulting in an amount transferred from preferred stock to common
stock within shareholders' equity of $504.
23
25
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
The Corporation has consistently had qualifying capital under the
risk-based capital requirements in excess of those required to meet
the "well-capitalized" standards. For further details on capital
ratios, see Note 12.
The Corporation trades under the symbol SECD on the NASDAQ National
Market System. As of December 31, 1997, there were 1,918
shareholders of record. The total market capitalization of the
Corporation was approximately $172.5 million at December 31,
1997.
The table below lists the high and low trading prices for the common
stock by quarter for the last three years. The price ranges and per
share dividend figures set forth below have been adjusted to reflect
the two-for-one stock split effective May 1, 1997 and the
three-for-two stock split effective May 1, 1995.
QUARTER FIRST SECOND THIRD FOURTH YEAR
1997
High $18.50 $22.25 $24.50 $28.00 $28.00
Low 15.06 17.75 20.75 21.88 15.06
Dividends Paid .11 .12 .12 .12 .47
Dividends Declared .12 .12 .12 .12 .48
1996
High $14.94 $14.13 $17.00 $16.50 $17.00
Low 13.75 12.50 13.63 14.88 12.50
Dividends Paid .095 .11 .11 .11 .425
Dividends Declared .11 .11 .11 .11 .44
1995
High $10.91 $11.75 $15.00 $14.94 $15.00
Low 10.08 10.25 11.63 13.75 10.08
Dividends Paid .08 .095 .095 .095 .365
Dividends Declared .095 .095 .095 .095 .38
The Corporation's price for its common stock increased to a trading
range of $21.88 to $28.00 per share in the fourth quarter of 1997.
The common stock closed at $25.38 at December 31, 1997, representing
a 62% increase from the prior year-end close. Book value per common
share was $11.68 and $10.34 at December 31, 1997 and 1996,
respectively. The 1997 year-end book value included $.44 of
unrealized market appreciation in the securities available-for-sale
portfolio. The level of market depreciation did not impact the book
value of common stock at the end of 1996.
The Corporation has historically paid cash dividends on a quarterly
basis and has periodically paid stock dividends at the discretion of
the Board of Directors. The payment and amount of future dividends
on the common stock will be determined by the Board of Directors.
The payment will depend on, among other things, earnings, financial
condition and cash requirements of the Corporation at the time that
such payment is considered, and on the ability of the Corporation to
receive dividends from the Bank, the amount of which is subject to
regulatory limitations. For 1997, 1996, and 1995, the
dividend-payout ratio for the Corporation was 36.19%, 34.78% and
29.67%, respectively.
- ------------------------------------------------------------------------------
LIQUIDITY
Management of the Corporation's liquidity position is necessary to
ensure that funds are available to meet the cash flow needs of
depositors and borrowers as well as the operating cash needs of the
Corporation. Funds are available from a number of sources including
maturing securities, payments made on loans, the acquisition of new
deposits, the sale of packaged loans, borrowing from the FHLB
(current capacity of $72.8 million) and overnight lines of credit of
$37.5 million through correspondent banks. The parent company has
three major sources of funding including dividends from the Bank, $15
million in unsecured lines of credit with correspondent banks which
mature during 1998, and access to the capital markets. The net cash
provided by operating activities for 1997, 1996 and 1995 were
approximately $13, $14 and $6 million, respectively. As discussed in
Note 12, the Bank is subject to regulation and may be limited in its
ability to pay dividends to the parent company. Accordingly,
consolidated cash flows may not represent cash available to common
stockholders.
24
26
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
The sections that follow, Market Risk Management and Other, contain
certain forward-looking statements (as defined in the Private
Securities Litigation Reform Act of 1995). These forward-looking
statements may involve significant risks and uncertainties. Although
the Corporation believes that the expectations reflected in such
forward-looking statements are reasonable, actual results may differ
materially from the expectations discussed in these forward-looking
statements.
MARKET RISK MANAGEMENT:
Market risk is the risk of economic loss from adverse changes in the
fair value of financial instruments due to changes in (a) interest
rates, (b) foreign exchange rates, or (c) other factors that relate
to market volatility of the rate, index, or price underlying the
financial instrument. The Corporation's market risk is composed
primarily of interest rate risk. The Corporation's Asset/Liability
Committee (ALCO) is responsible for reviewing the interest rate
sensitivity position of the Corporation and establishing policies to
monitor and limit the exposure to interest rate risk. Since nearly
the Corporation's entire interest rate risk exposure relates to the
financial instrument activity of the Bank, the Bank's Board of
Directors review the policies and guidelines established by ALCO.
The primary objective of asset/liability management is to provide an
optimum and stable net interest margin, after-tax return on assets
and return on equity capital, as well as adequate liquidity and
capital. Interest rate risk is monitored through the use of two
complementary measures: dynamic gap analysis and earnings simulation
models. While each of the measurement techniques has limitations,
taken together they represent a reasonably comprehensive tool for
measuring the magnitude of interest rate risk inherent in the
Corporation.
The dynamic gap analysis measures the amount of repricing risk
associated with the balance sheet at a specific point in time.
Expected cash flows from fixed rate instruments are defined
utilizing contractual maturities and anticipated cash flows through
early repayment of loans, early calls and paydowns of securities and
early withdrawals of deposits. Variable rate instrument's repricing
frequencies are categorized according to their earliest repricing
opportunity. Core deposits with noncontractual maturities are
included in the gap repricing distributions based on historical
patterns of pricing behavior.
The earnings simulation model forecasts earnings for a one-year time
horizon under a variety of interest rate scenarios. Management
evaluates the impact of the various rate simulations against
earnings in a stable interest rate environment. The most recent
model projects net income would increase by 2.9% if interest rates
would immediately fall by 200 basis points. It projects a decrease
in net income of 2.8% if interest rates would immediately rise by
200 basis points. The model projects net income would decrease by
1.0% if interest rates would gradually rise by 200 basis points over
a one-year time horizon. Management believes this reflects a slight
liability sensitive position for the one-year time horizon. The
earnings simulation model includes assumptions about how the various
components of the balance sheet and rate structure are likely to
react through time in different interest rate environments. These
assumptions are derived from historical analysis and Management's
outlook.
Interest rate sensitivity is managed through the use of security
portfolio management techniques, the use of fixed rate long-term
borrowings from the FHLB, the establishment of rate and term
structures for time deposits and loans and the sale of long-term
fixed rate mortgages through the secondary mortgage market. Although
the Corporation has available to it the use of off-balance sheet
swap instruments to manage interest rate risk, these instruments are
historically rarely utilized. Management expects interest rates to
be relatively stable with a slight downward bias during 1998 and
believes that the current modest level of liability sensitivity is
appropriate.
- -------------------------------------------------------------------------------
OTHER
YEAR 2000:
The Corporation has initiated the process of preparing its computer
systems and applications for the Year 2000. This process involves
modifying or replacing certain hardware and software used by the
Corporation. The software utilized is primarily originated and
serviced by external providers. The Corporation is communicating with
those providers to ensure that appropriate steps are being taken to
remedy any Year 2000 issues. Management expects to have all necessary
system and application changes identified in 1998. Substantially all
testing will be completed as well in 1998. Total cost associated with
the process, including the cost of acquiring certain hardware and
software and the internal and external costs relating to modifying
the systems will be approximately $1 million. Purchased hardware and
software will be capitalized in accordance with normal policy.
Personnel and all other costs related to the process are being
expensed as incurred. The costs of the process and the expected
completion dates are based on Management's best estimates.
25
27
UNAUDITED QUARTERLY RESULTS OF OPERATIONS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
The following is a summary of the quarterly results of operations for
the years ended December 31, 1997 and 1996 (per share data
retroactively restated for a two-for-one stock split effective May 1,
1997).
THREE MONTHS ENDED
MAR. 31 JUNE 30 SEPT. 30 DEC. 31
1997
Interest income $16,364 $16,900 $17,302 $17,681
Interest expense 7,942 8,196 8,633 8,725
Net interest income 8,422 8,704 8,669 8,956
Provision for loan losses 761 782 1,057 1,339
Other income 2,016 2,114 2,317 2,162
Security gains (losses) 31 368 34 162
Other expenses 6,930 7,743 6,992 6,926
Income before federal income taxes 2,778 2,661 2,971 3,015
Federal income taxes 628 470 666 686
Net income 2,150 2,191 2,305 2,329
Earnings per common share:
Basic $0.32 $0.33 $0.34 $0.34
Diluted $0.32 $0.32 $0.34 $0.34
1996
Interest income $16,061 $16,270 $16,539 $16,776
Interest expense 7,784 7,930 7,961 8,110
Net interest income 8,277 8,340 8,578 8,666
Provision for loan losses 755 693 2,788 720
Other income 1,761 1,874 1,944 2,438
Security gains (losses) 35 36 376 15
Other expenses 6,507 6,634 6,163 6,972
Income before federal income taxes 2,811 2,923 1,947 3,427
Federal income taxes 738 745 264 809
Net income 2,073 2,178 1,683 2,618
Earnings per common share:
Basic $0.34 $0.35 $0.25 $0.39
Diluted $0.31 $0.32 $0.25 $0.39
Additional discussion regarding the Company's liquidity and capital resources
are set forth in Notes 9, 10, 11, and 12 of Item 8; Financial Statements and
Supplementary Data and is incorporated herein by reference.
26
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CONSOLIDATED BALANCE SHEETS
SECOND BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
ASSETS DECEMBER 31
(DOLLARS IN THOUSANDS) 1997 1996
Cash and demand balances due from banks $ 24,367 $ 27,934
Federal funds sold 10,000 10,000
Securities, Available-for-sale (at market value) 280,010 231,324
Loans 566,492 565,737
Less reserve for loan losses 6,855 7,300
--------------------------------
Net loans 559,637 558,437
Premises and equipment 9,924 8,918
Accrued interest receivable 6,188 5,086
Goodwill and intangible assets 2,949 3,701
Other assets 20,405 21,879
--------------------------------
Total assets $ 913,480 $ 867,279
================================
- ----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand - non-interest bearing $ 93,080 $ 80,328
Demand - interest bearing 64,796 69,326
Savings 155,127 156,180
Time deposits 390,263 363,563
--------------------------------
Total deposits 703,266 669,397
Federal funds purchased and securities sold
under agreements to repurchase 111,327 86,787
Note payable 0 5,000
Other borrowed funds 3,492 3,989
Federal Home Loan Bank advances 9,864 26,557
Accrued expenses and other liabilities 6,103 6,312
--------------------------------
Total liabilities 834,052 798,042
Shareholders' equity:
Preferred stock, no par value;
Series A: 1,500,000 shares authorized; 718,750
issued and 0 and 300 shares outstanding
in 1997 and 1996, respectively 0 6
Series B: 1,500,000 shares authorized 0 0
Common stock, no par value; 20,000,000 shares authorized;
6,850,663 and 6,717,174 shares issued in
1997 and 1996, respectively 29,302 27,398
Treasury stock, 50,400 and 20,000 shares, respectively (793) (319)
Net unrealized gains (losses) on
available-for-sale securities, net of tax 3,016 (24)
Retained earnings 47,903 42,176
--------------------------------
Total shareholders' equity 79,428 69,237
--------------------------------
Total liabilities and shareholders' equity $ 913,480 $ 867,279
================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
27
29
CONSOLIDATED STATEMENTS OF INCOME
SECOND BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
INTEREST INCOME FOR THE YEAR
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995
Loans (including fees):
Taxable $ 51,272 $ 50,621 $ 48,303
Exempt from federal income taxes 636 740 810
Securities:
Taxable 12,869 11,789 11,167
Exempt from federal income taxes 2,854 2,205 1,635
Federal funds sold 616 291 629
---------------------------------------------
Total interest income 68,247 65,646 62,544
- ----------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 26,047 26,343 25,415
Federal funds purchased and securities
sold under agreements to repurchase 5,175 3,917 4,307
Note payable 276 371 434
Other borrowed funds 157 144 181
Federal Home Loan Bank advances 1,841 1,010 466
---------------------------------------------
Total interest expense 33,496 31,785 30,803
---------------------------------------------
Net interest income 34,751 33,861 31,741
Provision for loan losses 3,939 4,956 3,000
---------------------------------------------
Net interest income after provision for loan losses 30,812 28,905 28,741
- ----------------------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Service charges on deposit accounts 3,021 2,684 2,406
Trust fees 2,562 2,335 2,227
Security gains 595 462 634
Other 3,026 2,998 2,278
---------------------------------------------
Total non-interest income 9,204 8,479 7,545
---------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and employee benefits 13,450 12,618 11,702
Net occupancy 3,117 3,017 2,955
Equipment 2,069 1,546 1,340
Professional services 1,579 1,400 1,534
Assessment on deposits and other taxes 950 891 1,932
Amortization of goodwill and other intangibles 752 864 1,000
Other 6,674 5,940 5,563
---------------------------------------------
Total non-interest expense 28,591 26,276 26,026
---------------------------------------------
Income before federal income taxes 11,425 11,108 10,260
Income tax expense (benefit):
Current 2,540 2,767 3,516
Deferred (90) (211) (821)
---------------------------------------------
Total federal income tax expense 2,450 2,556 2,695
---------------------------------------------
NET INCOME $ 8,975 $ 8,552 $ 7,565
=============================================
Preferred stock dividends 0 (456) (1,066)
---------------------------------------------
Net income applicable to common stock $ 8,975 $ 8,096 $ 6,499
=============================================
NET INCOME PER COMMON SHARE
Basic $1.33 $1.33 $1.29
Diluted $1.32 $1.27 $1.13
Weighted average common shares outstanding:
Basic 6,749,435 6,070,666 5,056,242
Diluted 6,810,266 6,749,552 6,685,384
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
28
30
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
SECOND BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
UNREALIZED
(DOLLARS IN THOUSANDS, PREFERRED COMMON TREASURY HOLDING RETAINED
EXCEPT PER SHARE DATA) STOCK STOCK STOCK (LOSS) GAIN EARNINGS TOTAL
Balance, January 1, 1995 $ 13,235 $ 13,140 $ 0 $ (2,820) $ 32,328 $ 55,883
Net income 7,565 7,565
Cash dividends declared:
Common stock ($.38 per share) (1,928) (1,928)
Preferred stock ($1.50 per share) (1,066) (1,066)
Exercise of stock options 33 33
Common stock issued -
dividend reinvestment plan 478 478
Conversion of preferred stock to
common stock (504) 504 0
Change in unrealized market value
adjustment on securities available-
for-sale, net of tax 5,068 5,068
--------------------------------------------------------------------------
Balance, December 31, 1995 12,731 14,155 0 2,248 36,899 66,033
Net income 8,552 8,552
Cash dividends declared:
Common stock ($.44 per share) (2,816) (2,816)
Preferred stock ($.75 per share) (456) (456)
Exercise of stock options 276 276
Common stock issued -
dividend reinvestment plan 271 271
Conversion of preferred stock to
common stock (12,700) 12,696 (4)
Redemption of preferred stock (25) (3) (28)
Purchase of treasury stock (319) (319)
Change in unrealized market value
adjustment on securities available-
for-sale, net of tax (2,272) (2,272)
--------------------------------------------------------------------------
Balance, December 31, 1996 6 27,398 (319) (24) 42,176 69,237
Net income 8,975 8,975
Cash dividends declared:
Common stock ($.48 per share) (3,248) (3,248)
Exercise of stock options 717 717
Common stock issued -
dividend reinvestment plan 1,183 1,183
Conversion of preferred stock to
common stock (6) 4 (2)
Purchase of treasury stock (474) (474)
Change in unrealized market value
adjustment on securities available-
for-sale, net of tax 3,040 3,040
--------------------------------------------------------------------------
Balance, December 31, 1997 $ 0 $ 29,302 $ (793) $ 3,016 $ 47,903 $ 79,428
==========================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
29
31
CONSOLIDATED STATEMENTS OF CASH FLOWS
SECOND BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
OPERATING ACTIVITIES FOR THE YEAR
(DOLLARS IN THOUSANDS) 1997 1996 1995
Net income $ 8,975 $ 8,552 $ 7,565
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 3,939 4,956 3,000
Provision for depreciation 1,710 1,248 1,054
Provision for amortization of intangibles 752 864 1,000
(Accretion) amortization of investment
discount and premium (139) 242 590
Deferred income taxes (90) (211) (821)
Securities gains (595) (462) (634)
Other gains, net (1,099) (684) (408)
Increase in interest receivable (1,102) (58) (200)
(Decrease) increase in interest payable (186) (284) 789
Originations of loans held-for-sale (38,116) (38,005) (17,977)
Proceeds from sales of loans held-for-sale 39,204 38,679 18,367
(Increase) decrease in other assets (2) 109 (8,886)
(Decrease) increase in other liabilities (23) (930) 2,368
------------------------------------------
Net cash provided by operating activities 13,228 14,016 5,807
- ----------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from maturities of securities
- held-to-maturity 0 0 19,974
Proceeds from maturities of securities
- available-for-sale 52,418 67,997 46,392
Proceeds from sales of securities
- available-for-sale 43,100 60,299 66,232
Donation of securities to establish
charitable foundation 824 0 0
Purchases of securities - held-to-maturity 0 0 (250)
Purchases of securities - available-for-sale (139,688) (126,309) (133,956)
Net increase in revolving credit receivables (5,145) (4,455) (1,257)
Net decrease (increase) in loans 6 (31,496) (29,413)
Net increase in premises and equipment (2,705) (2,880) (2,547)
------------------------------------------
Net cash used for investing activities (51,190) (36,844) (34,825)
- ----------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase (decrease) in demand, interest bearing demand
and savings deposits 7,169 (18,040) (6,338)
Net increase in time deposits 26,700 29,586 48,426
Net increase (decrease) in federal funds purchased and securities
sold under agreements to repurchase 24,540 (155) (7,816)
Decrease in note payable (5,000) 0 0
Net (decrease) increase in other borrowed funds (497) 825 (504)
Net (repayments) advances from Federal Home Loan Bank (16,693) 19,161 (352)
Cash dividends (3,248) (3,272) (2,994)
Redemption / conversion of preferred stock (2) (32) 0
Purchase of treasury stock (474) (319) 0
Issuance of common stock 1,900 547 511
------------------------------------------
Net cash provided by financing activities 34,395 28,301 30,933
------------------------------------------
(Decrease) increase in cash and cash equivalents (3,567) 5,473 1,915
Cash and cash equivalents at beginning of year 37,934 32,461 30,546
------------------------------------------
Cash and cash equivalents at end of year $34,367 $37,934 $32,461
==========================================
Supplementary Cash Flow Information:
Cash paid for 1) Federal income taxes - $2,900, $3,285, and $3,713 for the
years ended December 31, 1997, 1996 and 1995, respectively; and 2) Interest -
$33,682, $32,068, and $30,014 for the years ended December 31, 1997, 1996 and
1995, respectively.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
30
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
1. STATEMENT OF ACCOUNTING POLICIES
Nature of Operations: Second Bancorp, Inc. (the Corporation) is a one bank
holding company with its sole subsidiary being The Second National Bank of
Warren (the Bank), headquartered in Warren, Ohio, with 26 branches and one loan
production office operating in Northeast Ohio. In addition to general commercial
banking, the Bank engages in trust and mortgage banking activities and other
financially related businesses.
The accounting policies followed by Second Bancorp, Inc. conform to generally
accepted accounting principles and to general practice within the banking
industry. The following is a description of the more significant accounting
policies:
a. Principles of Consolidation: Significant intercompany balances and
transactions between the Corporation and the Bank have been eliminated.
b. Use of Estimates: The preparation of the 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 these
estimates.
c. Securities: Debt and equity securities are classified as held-to-maturity,
available-for-sale, or trading. Securities classified as held-to-maturity
are measured at amortized or historical cost, securities available-for-sale
and trading are at fair value. Adjustments to fair value of the securities
available-for-sale, in the form of unrealized gains and losses, are
excluded from earnings and reported net of tax as a separate component of
shareholders' equity. Adjustments to fair value of securities classified as
trading are included in earnings. Management determines the appropriate
classification of debt securities at the time of purchase and reevaluates
such designation as of each balance sheet date. Debt securities are
classified as held-to-maturity when the Corporation has the positive intent
and ability to hold the securities to maturity. Effective, November 30,
1995, the Corporation reclassified all securities as available-for-sale as
permitted by a special report; "A Guide to Implementation of Statement No.
115 on Accounting for Certain Investments in Debt and Equity Securities"
issued by the Financial Accounting Standards Board (FASB). The effect of
the reclassification was to transfer $120,273 in securities from
held-to-maturity to available-for-sale. There were unrealized gains of
$1,968 on the securities at the time of the transfer. Classifying
securities as available-for-sale allows the Corporation to sell securities
to fund liquidity and manage the Corporation's interest rate risk. The
Corporation does not maintain a trading account.
The amortized cost of the debt securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity or, in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Interest and dividends are included in interest income from
investments. Realized gains and losses, and declines in value judged to be other
than temporary are included in net securities gains (losses). The cost of
securities sold is based on the specific identification method.
d. Revenue Recognition: Interest on loans is accrued and credited to
operations based upon the principal amount outstanding. Premiums on
acquired loans have been deducted from the related interest income and are
amortized over the remaining useful life of the loans acquired. Discounts
and premiums on acquired deposits have been deducted or added respectively
from the related interest expense and are being accreted or amortized over
the remaining useful life of the deposits. The accrual of interest income
generally is discontinued when a loan becomes, in Management's opinion,
doubtful of being collectible. When interest accruals are discontinued,
interest credited to income for the current year's is reversed, and
interest accrued in prior years is charged to the reserve for loan losses.
31
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
The Corporation accounts for loan origination and commitment fees and certain
direct loan origination costs by deferring the net fees, or net costs, and
amortizing them as an adjustment of the related loan's yield. The Corporation is
amortizing these amounts over the contractual life of the related loans. Net
unamortized deferred costs, primarily representing costs of acquiring indirect
automobile loans, were $1,132 and $2,809 at December 31, 1997 and 1996,
respectively.
In 1995, the Corporation adopted Statement of Financial Accounting Standard
(SFAS) No. 122, "Accounting for Mortgage Servicing Rights," which requires
companies to recognize as separate assets the value of mortgage servicing
rights, whether those rights are acquired through loan origination activities or
through purchase activities. Capitalized mortgage servicing rights are amortized
on an accelerated basis over the estimated life of the loans sold. Management
evaluates the recoverability of the mortgage servicing rights in relation to the
impact of actual and anticipated loan portfolio prepayments, foreclosures, and
delinquency experience. There was no valuation allowance associated with the
mortgage servicing rights portfolio as of December 31, 1997 and 1996. The impact
of adopting this standard was not material.
e. Loans Available-for-Sale: From time to time, the Corporation will sell
loans it originated, mostly mortgages.
The loans are reclassified as available-for-sale and are recorded at the
aggregate cost or market by loan. As of December 31, 1997 and 1996, the
Corporation had no loans available-for-sale.
f. Reserve for Loan Losses: The reserve for loan losses is maintained at a
level believed adequate by Management to absorb potential losses in the
loan portfolio. Management's determination of the adequacy of the reserve
is based upon an evaluation of the collectibility of the loans. These
evaluations take into consideration such factors as changes in the nature
and volume of the loan portfolio, current economic conditions that may
affect the borrower's ability to pay, overall quality, and a review of
specific problem loans. Effective January 1, 1995, the Corporation adopted
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan
- Income Recognition and Disclosures." These standards address the
accounting for certain loans when it is probable that amounts due pursuant
to the contractual terms of the loan will not be collected. This evaluation
is inherently subjective and requires a material estimate, including the
amounts and timing of future cash flows expected to be received on impaired
loans, that could be susceptible to change. To determine the amount of
impaired loans, the Corporation analyzes the expected cash flows of
commercial non-accrual loans. To the extent that the net present value of
expected cash flows is less than the carrying amount of an individual loan,
the loan balance is included as impaired loans. The adoption of these
standards was not material.
g. Premises and Equipment: Premises and equipment are stated at cost, less
accumulated depreciation and amortization. The provision for depreciation
and amortization is computed generally by the straight-line method.
Leasehold improvements are amortized over the shorter of the terms of the
respective leases or the estimated useful lives.
h. Federal Income Taxes: Deferred federal income taxes are provided for
differences between tax and financial statement bases of assets and
liabilities at year-end. Deferred taxes are recognized using the liability
method, whereby tax rates are applied to cumulative temporary differences
based on when and how they are expected to affect the tax return. Deferred
tax assets and liabilities are adjusted for tax rate changes.
i. Intangible Assets: Intangible assets resulting from the excess of the
purchase price over net identifiable tangible assets acquired through
acquisitions are specifically identified when determinable. Any excess
(goodwill) is amortized based on the estimated useful life of the
long-term assets acquired and on an accelerated basis. The core deposit
intangible is amortized both on an accelerated basis and on a
straight-line basis over the estimated useful life. Original estimated
useful lives for the core deposit intangible and goodwill range from 10 to
14 years and 8 to 22 years, respectively. Accumulated amortization as of
December 31, 1997 and 1996 were $6,834 and $6,082, respectively.
j. Interest Rate Management: From time to time, the Bank may enter into
interest rate swap agreements to modify characteristics of its financial
assets and liabilities. These agreements involve the receipt of floating or
fixed rate interest in exchange for floating or fixed rate interest
payments over the life of the agreement without an exchange of the
underlying principal amount. The differential to be paid or received is
accrued as interest rates change and recognized as an adjustment to
interest income or expense related to the assets and liabilities. The
related amount payable to or receivable from counterparties is included in
other liabilities or assets. The fair values of the swap agreements are not
recognized in the financial statements. On December 31, 1997 and 1996, the
Bank was not a party to any interest rate swap agreements.
32
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
k. Cash Equivalents: Cash equivalents include amounts due from banks and
federal funds sold. Generally, federal funds are purchased and sold for
periods of less than 30 days.
l. Per Share Data: In 1997, the FASB issued SFAS No. 128, "Earnings per Share".
Statement 128 replaced the calculation of primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects of
options, warrants and convertible securities. Diluted earnings per share is
very similar to the previously reported fully diluted earnings per share.
All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to the Statement 128 requirements.
The Corporation had a two-for-one stock split on May 1, 1997 and a
three-for-two stock split on May 1, 1995. All of the share and per share
data have been restated to reflect these stock splits.
m. Reclassifications: Certain reclassifications have been made to amounts
previously reported in order to conform with current year presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
a. Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities: In June 1996, the FASB issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." The Statement provides consistent
standards for distinguishing transfers of financial assets that are sales
from transfers that are secured borrowings based on a control-oriented
"financing-components" approach. Under this approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets
it controls and liabilities it has incurred, derecognizes financial assets
when control has been surrendered and derecognizes liabilities when
extinguished. The provisions of SFAS No. 125 are effective for transactions
occurring after December 31, 1996, except those provisions relating to
repurchase agreements, securities lending, and other similar transactions
and pledged collateral, which have been delayed until after December 31,
1997 by SFAS No. 127, "Deferral of the Effective Date of Certain Provisions
of FASB Statement No. 125, an amendment of FASB Statement No. 125." The
adoption of these statements did not have a material impact on financial
position or results of operations in 1997 and the remaining adoption in
1998 is not expected to have a material impact on financial position or
results of operations.
b. Reporting Comprehensive Income: In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income". This statement establishes standards for
reporting the components of comprehensive income and requires that all items
that are required to be recognized under accounting standards as components
of comprehensive income be included in a financial statement that is
displayed with the same prominence as other financial statements.
Comprehensive income includes net income as well as certain items that are
reported directly within a separate component of stockholders' equity and
bypass net income. The provisions of this statement are effective beginning
with 1998 interim reporting. These disclosure requirements will have no
impact on the financial position or results of operations.
3. RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The Bank is required to maintain average reserve balances with the Federal
Reserve Bank. The average amount of those reserve balances for the year ended
December 31, 1997 was approximately $2,041, which includes a $1,750 compensating
balance for services provided by the Federal Reserve Bank during 1997.
33
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
4.SECURITIES, AVAILABLE FOR SALE
The following is a summary of securities:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1997 COST GAINS LOSSES VALUE
U.S. Treasury securities and obligations of other
U.S. Government agencies and corporations $ 92,334 $ 762 $ (49) $ 93,047
Obligations of states and political subdivisions 60,933 2,114 (16) 63,031
Corporate securities 10,263 30 (5) 10,288
Mortgage-backed securities 104,907 1,596 (169) 106,334
-----------------------------------------------------------
Total debt securities 268,437 4,502 (239) 272,700
Equity securities 7,004 306 0 7,310
-----------------------------------------------------------
Total securities $ 275,441 $ 4,808 $ (239) $ 280,010
===========================================================
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1996 COST GAINS LOSSES VALUE
U.S. Treasury securities and obligations of other
U.S. Government agencies and corporations $ 76,764 $ 134 $ (371) $ 76,527
Obligations of states and political subdivisions 50,727 1,149 (126) 51,750
Corporate securities 1,003 0 (1) 1,002
Mortgage-backed securities 96,648 371 (1,465) 95,554
-----------------------------------------------------------
Total debt securities 225,142 1,654 (1,963) 224,833
Equity securities 6,219 272 0 6,491
-----------------------------------------------------------
Total securities $ 231,361 $ 1,926 $ (1,963) $231,324
===========================================================
The amortized cost and estimated market value of securities on December 31, 1997
by contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without prepayment penalties.
ESTIMATED
AMORTIZED MARKET
COST VALUE
Under 1 year $ 42,941 $ 42,956
1 to 5 years 66,559 67,671
5 to 10 years 47,327 48,930
Over 10 years 6,703 6,809
--------------------------------
163,530 166,366
Mortgage-backed securities 104,907 106,334
Equity securities 7,004 7,310
--------------------------------
$275,441 $280,010
================================
Information relating to sales of available-for-sale securities for the three
years ended December 31, 1997 is as follows:
1997 1996 1995
Proceeds from sales of securities $ 43,100 $ 60,299 $ 66,232
Gross realized gains $ 691 $ 590 $ 1,022
Gross realized losses (96) (128) (388)
Income tax associated with net gains 202 157 216
-----------------------------------------------
After tax gain $ 393 $ 305 $ 418
-----------------------------------------------
Impact on dilutive earnings per share $ 0.06 $ 0.05 $ 0.08
===============================================
On December 31, 1997 and 1996, securities with a carrying value of $204,526 and
$185,753, respectively, were pledged to secure repurchase agreements, deposits
of public funds, and for other purposes.
34
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
5. LOANS
Loans consist of the following:
DECEMBER 31
1997 1996
Commercial $306,746 $297,347
Consumer 180,588 205,409
Real estate 79,158 62,981
--------------------------
$566,492 $565,737
==========================
At December 31, 1997 and 1996, the Corporation serviced mortgage and Small
Business Administration (SBA) loans for others totaling $46,948 and $47,986,
respectively. Amounts capitalized as originated servicing rights were $144 and
$72 in 1997 and 1996, respectively. Capitalized servicing rights amortized were
$57 and $29 in 1997 and 1996, respectively.
The Bank has granted loans to certain officers and directors of both the
Corporation and the Bank and their associates. Related-party loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons. The
aggregate dollar amounts of these loans were $8,231 and $5,587 at December 31,
1997 and 1996, respectively. New loans and advances totaled $5,780 and payments
were $3,136 in 1997.
- --------------------------------------------------------------------------------
6. ASSET QUALITY
Reserve for loan losses:
Changes in the reserve for loan losses for each of the last three years ended
December 31 were as follows:
1997 1996 1995
Balance at beginning of year $7,300 $6,748 $6,126
Charge-offs (5,138) (5,180) (3,000)
Recoveries 754 776 622
------------------------------------------
Net charge-offs (4,384) (4,404) (2,378)
Provision for loan losses 3,939 4,956 3,000
------------------------------------------
Balance at end of year $6,855 $7,300 $6,748
==========================================
Reserve for loan losses as a percent of total loans 1.21% 1.29% 1.26%
Non-accrual, past-due and restructured loans (non-performing loans):
Non-accrual loans are loans that are no longer earning interest at the
discretion of Management. This occurs when Management determines that the
borrower can no longer service the debt, but the loan is adequately secured with
collateral or the borrower is able to repay the principal portion of the loan in
the future. Past-due loans are loans with principal payments more than 90 days
past due. Both interest and principal are expected to be repaid. Restructured
loans include loans whose original terms were redesigned to allow the customer
to remain current and repay the loan. Also listed is other real estate owned
which represents real estate acquired through the default of loans. The Bank's
practice is to carry other real estate owned at the lower of cost or fair market
value, less estimated costs to sell.
DECEMBER 31 1997 1996
Non-accrual loans $4,492 $6,809
Past-due loans 970 1,963
Restructured loans 13 171
--------------------------------
Total $5,475 $8,943
================================
Percent of total loans at year end .97% 1.58%
Other real estate owned (net of reserve) $ 0 $ 0
During 1997, the obligations of one of the Bank's borrowers were included in
non-performing loans as of December 31, 1996 and the first three quarters of
1997, and were settled with the Bank by placing approximately $2.7 million in a
third party trust. An unsecured creditor, who is subordinate to the Bank, has
challenged the Bank's claims on these funds in bankruptcy court. The Bank
reclassified the remaining loan balance of $2.4 million to other assets as of
December 31, 1997.
While there can be no assurance as to the ultimate collectibility of this
receivable, in consultation with outside counsel, the Bank believes it will
ultimately receive an amount from the trust that would not result in a material
effect on the financial position or results of operations.
For the year ended December 31, 1997, interest income that would have been
earned under the original terms of the loans classified in non-accrual and
restructured loans in the above schedule amounted to $871. No interest income
was realized on these loans for 1997. Loans that were considered to be impaired
under SFAS No. 114 totaled $1,864 and $2,914 as of December 31, 1997 and 1996,
respectively, all of which were included in non-performing assets as of those
dates.
35
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
7. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," requires that the Corporation disclose estimated fair
values for its financial instruments. The market value of
securities, as presented in Note 4, is based primarily upon quoted
market prices. For substantially all other financial instruments,
the fair values are Management's estimates of the values at which
the instruments could be exchanged in a transaction between willing
parties. In accordance with SFAS No. 107, fair values are based on
estimates using present value and other valuation techniques in
instances where quoted prices are not available. These techniques
are significantly affected by the assumptions used, including
discount rates and estimates of future cash flows. As such, the
derived fair values estimates cannot be substantiated by comparison
to independent markets and, further, may not be realizable in an
immediate settlement of the instruments. SFAS No. 107 also excludes
certain items from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent, and should
not be construed to represent, the underlying value of the
Corporation. The following table presents the estimates of fair
value of financial instruments:
DECEMBER 31, 1997 DECEMBER 31, 1996
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
Assets:
Cash and cash equivalents $ 34,367 $ 34,367 $ 37,934 $ 37,934
Securities 280,010 280,010 231,324 231,324
Loans 566,484 558,335 565,697 556,714
Allowance for loan losses (6,855) - (7,300) -
Liabilities:
Demand deposits - non-interest bearing 93,080 93,080 80,328 80,328
Demand deposits - interest bearing 64,796 64,796 69,326 69,326
Savings deposits 155,127 155,127 156,180 156,180
Time deposits 390,263 392,545 363,563 365,187
Federal funds purchased and securities
sold under agreements to repurchase 111,327 111,327 86,787 86,787
Note payable 0 0 5,000 5,000
Other borrowed funds 3,492 3,492 3,989 3,989
FHLB advances 9,864 9,565 26,557 26,679
Fair value estimates, methods, and assumptions are set forth below
for the Corporation's financial instruments:
Cash and cash equivalents: The carrying amounts reported in the
balance sheet for cash and cash equivalents approximate those
assets' fair value.
Securities: Fair values for securities are based on quoted market
prices, where available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable
instruments.
Loans: Variable-rate loans that reprice frequently are assumed to
have a short-duration period, yielding a fair value that
approximates the carrying value. The fair values for other loans are
estimated using a discounted cash flow calculation.
Deposit liabilities: The fair values disclosed for demand deposits,
insured money market and interest checking accounts, and savings
accounts are, by definition, equal to the amount payable on demand
at the reporting date (i.e., their carrying amounts). The carrying
amounts for time deposits are estimated using a discounted cash flow
calculation. Variable-rate time deposits that reprice frequently are
assumed to have a short-duration period, yielding a fair value that
approximates the carrying value.
Federal funds purchased, securities sold under agreements to
repurchase, notes payable, and other short-term borrowings: The
carrying amounts of federal funds purchased, securities sold under
agreements to repurchase, and other short-term borrowings
approximate their fair values.
As of December 31, 1997 and 1996, the Corporation had no
outstanding off-balance sheet instruments.
36
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
8. PREMISES AND EQUIPMENT
The following is a summary of Bank premises and equipment accounts as
of December 31:
1997 1996
Land and buildings $ 1,112 $1,207
Leasehold improvements 5,004 4,575
Furniture and equipment 13,728 11,413
------------------------
19,844 17,195
Less:
Accumulated depreciation and amortization 9,920 8,277
----------------------
$9,924 $8,918
======================
- -------------------------------------------------------------------------------
9. FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Corporation had outstanding $5 million in federal funds purchased
at the end of 1995 at a rate of 6.0%. There were no federal funds
purchased at December 31, 1997 or 1996. The Corporation has
repurchase agreements with corporate customers and local
municipalities. These borrowings have an overnight maturity and are
collateralized with U. S. Treasury and government agency securities,
including agency-issued mortgage-backed securities with a market
value of $127,496 and $97,341 as of December 31, 1997 and 1996,
respectively. The securities are held in the Corporation's
safekeeping account at the Federal Reserve Bank. The following table
summarizes certain information relative to both these borrowings:
1997 1996 1995
Outstanding at December 31 $111,327 $ 86,787 $ 86,942
Weighted-average interest rate at December 31 4.63% 4.31% 4.40%
Maximum amount outstanding as of any month end $119,032 $101,182 $101,215
Average amount outstanding $105,685 $ 89,601 $ 89,026
Approximate weighted-average interest rate during the year 4.68% 4.37% 4.84%
- -------------------------------------------------------------------------------
10. NOTE PAYABLE
At December 31, 1996, the Corporation had a $5 million unsecured note
with a correspondent bank. The note was paid in full in 1997,
primarily from funds received through dividends paid from the
subsidiary. As of December 31, 1997, the Corporation has available a
total of $15 million in unsecured lines of credit with two
correspondent banks. The term of the $10 million line of credit
matures on September 15, 1998 and the term of the $5 million line of
credit matures on December 31, 1998. Both lines bear interest at a
floating rate based on several indices including LIBOR, Federal funds
or prime rate.
- -------------------------------------------------------------------------------
11. OTHER BORROWED FUNDS AND FEDERAL HOME LOAN BANK ADVANCES
The Corporation has a Treasury Note Option Agreement with the Federal
Government which allows the Corporation to hold funds deposited by
customers for treasury and tax payments to the Government up to a
self-imposed limit of $6,000,000. Federal Home Loan Bank (FHLB)
advances are collateralized by all shares of FHLB stock and a portion
of the Corporation's qualified mortgage loan portfolio (approximately
$14,901 and $40,332 at December 31, 1997 and 1996, respectively), and
are used to fund mortgage loan originations of the Corporation and as
a regular funding source. The detail of these borrowings on December
31, 1997 and 1996 is as follows:
CURRENT
INTEREST DECEMBER 31
DESCRIPTION RATES 1997 1996
Treasury note option account 5.19% $ 3,492 $ 3,989
Fixed rate FHLB advances, with monthly interest payments
Advances due in 1999 5.15% $ 3,000 $ 3,000
Fixed rate FHLB advances, with monthly principal
and interest payments
Advances due in 1999 to 2009 5.30% to 6.20% $ 6,864 $ 23,557
37
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
12. SHAREHOLDERS' EQUITY
The Corporation is authorized to issue 1,500,000 shares each of preferred stock,
Series A and B. On June 25 and July 7, 1993, the Corporation issued a total of
718,750 shares of $1.50 Cumulative Convertible Preferred Stock, Series A-1 (the
"preferred stock"), generating net proceeds of $13,235,000. During 1995, the
holders converted 27,384 shares of preferred stock to common stock. During 1996,
the Corporation exercised its option to redeem the remaining preferred stock
outstanding on June 25, 1997 at a price of $21.05 per share. As a result of this
action and other independent conversions by preferred shareholders, an
additional 689,900 shares converted into common stock at a rate of 2.2354 shares
of common stock for each share of preferred stock converted. An additional 1,466
shares were redeemed for cash.
Dividends are paid by the Corporation from its assets, which are mainly provided
by dividends from the Bank. However, certain restrictions exist regarding the
ability of the Bank to transfer funds to the Corporation in the form of cash
dividends, loans, or advances. The approval of the Comptroller of the Currency
is required to pay dividends in excess of the Bank's earnings retained in the
current year plus retained net profits from the preceding two years. As of
December 31, 1997, the Bank had retained earnings of $40,348, of which $6,465
was available for distribution to the Corporation as dividends without prior
regulatory approval.
On March 7, 1996 the Board of Directors authorized the Corporation to repurchase
up to 140,000 shares of its common stock. As of December 31, 1997, the
Corporation had repurchased 50,400 shares. The repurchase of any more than
140,000 shares of stock must first be approved by creditors.
The Corporation and the Bank are 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 Corporation's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Corporation and 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 Corporation's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined by the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
1997, that the Corporation and the Bank meet all capital adequacy requirements
to which it is subject.
As of December 31, 1997, the most recent notification from the Office of the
Comptroller of the Currency categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I risk-based
and Tier I leverage ratios as set forth in the table. There are no conditions or
events since that notification that Management believes have changed the Bank's
category.
38
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
The consolidated Corporation's and the subsidiary Bank's actual
capital amounts and ratios are also presented in the table.
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
AMOUNT RATIO AMOUNT RATIO
As of December 31, 1997:
Total capital (to risk-weighted assets):
Second Bancorp $80,388 12.6% greater than or equal to $50,884 greater than or equal to 8.0%
Second National Bank 75,032 11.8 greater than or equal to 50,701 greater than or equal to 8.0
Tier I capital (to risk-weighted assets):
Second Bancorp 73,533 11.6 greater than or equal to 25,442 greater than or equal to 4.0
Second National Bank 58,937 9.3 greater than or equal to 25,350 greater than or equal to 4.0
Tier I leverage:
Second Bancorp 73,533 8.2 greater than or equal to 35,769 greater than or equal to 4.0
Second National Bank 58,937 6.6 greater than or equal to 35,704 greater than or equal to 4.0
As of December 31, 1996:
Total capital (to risk-weighted assets):
Second Bancorp 72,951 11.8 greater than or equal to 49,348 greater than or equal to 8.0
Second National Bank 72,567 11.8 greater than or equal to 49,205 greater than or equal to 8.0
Tier I capital (to risk-weighted assets):
Second Bancorp 65,651 10.6 greater than or equal to 24,674 greater than or equal to 4.0
Second National Bank 56,547 9.2 greater than or equal to 24,603 greater than or equal to 4.0
Tier I leverage:
Second Bancorp 65,651 7.8 greater than or equal to 33,882 greater than or equal to 4.0
Second National Bank 56,547 6.7 greater than or equal to 33,809 greater than or equal to 4.0
TO BE WELL-CAPITALIZED UNDER
PROMPT CORRECTIVE ACTION PROVISIONS
AMOUNT RATIO
As of December 31, 1997:
Total capital (to risk-weighted assets):
Second Bancorp n/a
Second National Bank greater than or equal to $63,376 greater than or equal to 10.0%
Tier I capital (to risk-weighted assets):
Second Bancorp n/a
Second National Bank greater than or equal to 38,026 greater than or equal to 6.0
Tier I leverage:
Second Bancorp n/a
Second National Bank greater than or equal to 44,631 greater than or equal to 5.0
As of December 31, 1996:
Total capital (to risk-weighted assets):
Second Bancorp n/a
Second National Bank greater than or equal to 61,507 greater than or equal to 10.0
Tier I capital (to risk-weighted assets):
Second Bancorp n/a
Second National Bank greater than or equal to 36,904 greater than or equal to 6.0
Tier I leverage:
Second Bancorp n/a
Second National Bank greater than or equal to 42,261 greater than or equal to 5.0
- -------------------------------------------------------------------------------
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
1997 1996 1995
Numerator:
Net income $ 8,975 $ 8,552 $ 7,565
Preferred stock dividends 0 (456) (1,066)
---------------------------------------
Numerator for basic earnings per share -
income available to common stockholders 8,975 8,096 6,499
Effect of dilutive securities:
Preferred stock dividends 0 456 1,066
---------------------------------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions $ 8,975 $ 8,552 $ 7,565
========================================
Denominator:
Denominator for basic earnings per share -
weighted average shares 6,749,435 6,070,666 5,056,242
Effect of dilutive securities:
Employee stock options 60,831 57,154 39,332
Preferred stock 0 621,732 1,589,810
----------------------------------------
Dilutive potential common shares 60,831 678,886 1,629,142
----------------------------------------
Denominator for diluted earnings per
share - adjusted weighted-average
shares and assumed conversions 6,810,266 6,749,552 6,685,384
=========================================
Basic earnings per share $1.33 $1.33 $1.29
=========================================
Diluted earnings per share $1.32 $1.27 $1.13
=========================================
39
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
14. FEDERAL INCOME TAXES
The Corporation's federal income tax provision in the accompanying
statements of income differs from the statutory rate as follows:
1997 1996 1995
Statutory rate 34% 34% 34%
Income before federal income taxes $11,425 $ 11,108 $ 10,260
Tax at statutory rate $ 3,885 $ 3,777 $ 3,488
Tax effect of non-taxable interest (1,187) (1,001) (831)
Other items, net (248) (220) 38
----------------------------------------
$ 2,450 $ 2,556 $ 2,695
========================================
Significant components of the Corporation's deferred tax liabilities
and assets as of December 31 are as follows:
1997 1996
Deferred tax liabilities:
SFAS No. 115 adjustment $ 1,553 $ n/a
Other 552 337
------------------------
Total deferred tax liabilities 2,105 337
Deferred tax assets:
Provision for loan losses 2,331 2,482
SFAS No. 115 adjustment n/a 12
Non-accrual interest 634 468
Goodwill and intangible amortization 469 402
Deferred loan fees 271 257
Other 462 272
-------------------------
Total deferred tax assets 4,167 3,893
-------------------------
Net deferred tax assets $ 2,062 $ 3,556
========================
40
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
15. EMPLOYEE BENEFIT PLANS
The Corporation has a non-contributory, defined-benefit pension plan
covering substantially all of its employees. The benefits are based
on a percentage of the employee's average annual earnings multiplied
by completed years of continuous service. The Corporation's funding
policy is to contribute annually an amount between the minimum
required and the maximum amount that can be deducted for federal
income tax purposes. Contributions are intended to provide not only
for benefits attributed to service to date but also for those
expected to be earned in the future. The plan assets at December 31,
1997 are invested primarily in common stock, preferred stock, and
corporate bonds. The following table sets forth the plan's funded
status and amounts recognized in the Corporation's statements of
financial position on December 31:
1997 1996
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested
benefits of $3,768 in 1997 and $2,796 in 1996 $ 4,233 $ 3,210
Projected benefit obligation for service rendered to date $ 5,478 $ 5,624
Plan assets at fair value, primarily listed stocks and corporate bonds 6,978 5,864
------------------------
Plan assets in excess of projected benefit obligation (1,500) (240)
Unrecognized net gain from past experience different from that
assumed and effects of changes in assumptions 1,584 67
Unrecognized net assets at January 1 114 135
------------------------
(Accrued) prepaid pension costs included in other assets $ (198) $ 38
========================
Net pension cost included the following components:
1997 1996 1995
Service cost-benefits earned during the period $ 433 $ 532 $ 398
Interest cost on projected benefit obligation 367 408 351
Actual return on plan assets (1,218) (645) (1,385)
Net amortization and deferral 654 157 969
----------------------------------------
Net periodic pension expense $ 236 $ 452 $ 333
=======================================
Assumptions used in determining the actuarial present value of the
projected benefit obligation are as follows:
1997 1996 1995
Rates used for calculation of expense:
Interest rate for obligations 7.25% 7.5% 7.0%
Long-term rate of investment return 9.75 9.75 9.25
Salary increase rate 5.0 5.0 5.5
The Bank also has a supplemental retirement deferred benefit plan for
certain employees, which provides benefits in excess of the defined
benefit plan discussed above. As of December 31, 1997 and 1996, the
accumulated benefit obligation recorded in the financial statements
was $528 and $430, respectively. The plan expense for 1997, 1996, and
1995 was $98, $114, and $149, respectively. The Bank also has a stock
appreciation rights plan that was used to grant certain officers
stock appreciation rights upon their employ. The Corporation has not
issued any rights since 1987. As of December 31, 1997 and 1996, the
accumulated obligation for these rights recorded in the financial
statements was $394 and $204, respectively. The plan expense for 1997, 1996,
and 1995 was $190, $9, and $155, respectively.
The Bank also sponsors a defined contribution benefit plan covering
substantially all eligible employees of the Bank. The Bank voluntarily
contributes 75% of the participant's contribution to a maximum of 4.5% of the
participant's compensation. Participants, at their discretion, may invest in
several investment funds or a stock fund consisting solely of the Corporation's
common stock. The Bank's contribution is limited solely to the stock fund.
Contributions in 1997, 1996, and 1995 were $307, $286, and $257, respectively.
The Board of Directors of the Corporation has authorized the issuance of 99,000
shares of the Corporation's common stock for use in the Bank's defined
contribution benefit plan. As of December 31, 1997, none of the shares
authorized have been issued.
41
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
16. STOCK OPTIONS
The Corporation's incentive stock option plan authorizes the issuance of options
to purchase common stock to key officers primarily at the market price at the
date of grant. In May 1991 the plan was approved to provide 135,000 shares of
common stock to be used by the plan for a period of five years, limiting grants
to a maximum of 4,500 shares per officer per year. In May 1994 the plan was
amended to provide an additional 300,000 shares of common stock and an increase
of the maximum annual grant to 7,500 shares. The term of the plan was extended
to May 2000. The options are exercisable one year after issuance and expire
after ten years. Pro forma information regarding net income and earnings per
share is required by SFAS No. 123, "Accounting for Stock-Based Compensation" and
has been determined as if the Corporation had accounted for its employee stock
options under the fair value method of that Statement. Under the fair-value
based method, compensation cost is measured at the grant date based upon the
value of the award and recognized over the service period. The Corporation has
elected, as the standard allows, to continue to measure compensation costs for
its plans as prescribed in Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees" because the alternative fair value
accounting provided under SFAS No. 123 requires use of option valuation models
that were not developed for use in valuing employee stock options. Under APB No.
25, because the exercise price of the Corporation's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized. Pro forma disclosure of net income and
earnings per share is made in the accompanying footnotes as if the fair-value
method of accounting, as defined by SFAS No. 123, had been adopted.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions:
1997 1996 1995
Risk-free interest rate 5.5% 6.0% 6.0%
Dividend yield 3.0% 3.0% 3.0%
Volatility factor of expected market
price of Corporation's common stock .161 .137 .137
Weighted-average expected life 6 years 6 years 6 years
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the
Corporation's employee stock options have characteristics
significantly different from those of traded options, and because
changes in the subjective input assumptions can materially affect the
fair value estimate, in Management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value
of its employee stock options.
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Corporation's pro forma information follows:
1997 1996 1995
Pro forma net income $8,851 $8,473 $7,525
Pro forma earnings per share:
Basic $ 1.31 $ 1.32 $ 1.28
Diluted $ 1.30 $ 1.26 $ 1.13
A summary of stock option activity is as follows:
NUMBER OF OPTION PRICE
SHARES PER SHARE TOTAL
Outstanding at December 31, 1994 124,500 $4.33 - $10.58 $1,137
Granted 53,200 10.56 562
Exercised (4,500) 7.33 (33)
-----------------------------------------
Outstanding at December 31, 1995 173,200 4.33 - 10.58 1,666
Granted 63,300 13.44 850
Exercised (29,700) 7.33 - 10.58 (275)
-----------------------------------------
Outstanding at December 31, 1996 206,800 4.33 - 13.44 2,241
Granted 62,000 22.13 - 24.19 1,380
Exercised (75,400) 4.33 - 13.44 (716)
-----------------------------------------
Outstanding at December 31, 1997 193,400 $7.33 - $24.19 $2,905
========================================
Exercisable at December 31, 1997 131,400 $7.33 - $13.44 $1,525
The weighted-average fair value of the options granted during 1997,
1996 and 1995 were $4.05, $4.80 and $3.78, respectively. The
weighted-average remaining contractual life of the outstanding
options is 8.1 years.
42
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
17. PARENT COMPANY
Condensed financial information of Second Bancorp, Inc. (Parent Company only) is
as follows:
CONDENSED BALANCE SHEETS
DECEMBER 31
1997 1996
Assets:
Cash $ 2,036 $ 3,505
Available-for-sale securities 1,632 1,154
Loans 683 703
Investment in and advances to subsidiary, at equity
in underlying value of their net assets 75,650 69,048
Fixed assets 43 64
Other assets 946 769
------------------------
Total assets $80,990 $ 75,243
========================
Liabilities and Shareholders' Equity:
Accrued and other liabilities $ 1,562 $ 1,006
Note payable 0 5,000
Shareholders' Equity:
Preferred stock, no par value;
Series A: 1,500,000 shares authorized;
718,750 shares issued and 0 and 300
shares outstanding, respectively 0 6
Series B: 1,500,000 shares authorized 0 0
Common stock, no par value; 20,000,000
shares authorized; 6,850,663 and 6,717,174 shares
issued, respectively 29,302 27,398
Treasury stock, 50,400 and 20,000 shares, respectively (793) (319)
Net unrealized holding gains (losses) on
available-for-sale securities 3,016 (24)
Retained earnings 47,903 42,176
-------------------------
Total Liabilities and Shareholders' Equity $ 80,990 $ 75,243
=========================
CONDENSED STATEMENTS OF INCOME
Years ended December 31 1997 1996 1995
Income:
Cash dividends from subsidiary $ 7,722 $ 8,384 $ 3,384
Interest income 863 750 757
Gains on sale of securities 352 0 0
Other income 26 19 10
-----------------------------------------
Total income 8,963 9,153 4,151
Expenses:
Interest expense 276 371 432
Other expenses 1,669 559 663
-----------------------------------------
Total expenses 1,945 930 1,095
-----------------------------------------
Income before income taxes and equity in
undistributed earnings of subsidiary 7,018 8,223 3,056
Income tax benefit 363 60 116
Income before and equity in undistributed earnings
of subsidiary 7,381 8,283 3,172
Equity in undistributed earnings of subsidiary 1,594 269 4,393
-----------------------------------------
Net income $ 8,975 $ 8,552 $ 7,565
=========================================
43
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- -------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31 1997 1996 1995
Operating Activities:
Net income $8,975 $8,552 $7,565
Less: Equity in undistributed net income of subsidiary (1,594) (269) (4,393)
Provision for depreciation 29 26 15
Gain on sale of securities (352) 0 0
Other (net) 364 (42) 136
---------------------------------------
Cash provided by operations 7,422 8,267 3,323
Investing Activities:
Increase in loan to subsidiary (2,000) (2,000) 0
Net decrease (increase) in loans 20 19 (722)
Sale of securities 0 300 0
Purchase of securities (903) (482) (186)
Donation of securities to establish
charitable foundation 824 0 0
Purchase of premises and equipment (8) (63) 0
---------------------------------------
Cash used by investing activities (2,067) (2,226) (908)
Financing Activities:
Issuance of note payable 0 0 5,000
Repayment of note payable (5,000) 0 (5,000)
Redemption and conversion of preferred stock (2) (32) 0
Issuance of common stock 1,900 547 511
Purchase of treasury stock (474) (319) 0
Payment of dividend (3,248) (3,272) (2,994)
---------------------------------------
Cash used by financing activities (6,824) (3,076) (2,483)
---------------------------------------
(Decrease) increase in cash (1,469) 2,965 (68)
Cash at beginning of year 3,505 540 608
---------------------------------------
Cash at end of year $2,036 $3,505 $ 540
========================================
44
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SECOND BANCORP, INC. AND SUBSIDIARY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, 1997
- --------------------------------------------------------------------------------
18. COMMITMENTS AND CONTINGENT LIABILITIES
LOAN COMMITMENTS:
Loan commitments are made to accommodate the financial needs of the
Bank's customers; however, there are no long-term, fixed-rate loan
commitments that result in market risk. Standby letters of credit
commit the Bank to make payments on behalf of customers when certain
specified future events occur. They primarily are issued to
facilitate customers' trade transactions.
Both arrangements have credit risk essentially the same as that
involved in extending loans to customers and are subject to the
Bank's normal credit policies. Collateral (e.g., securities,
receivables, inventory, and equipment) is obtained based on
Management's credit assessment of the customer.
The Bank's maximum obligation to extend credit for loan commitments
(unfunded loans and unused lines of credit) and standby letters of
credit outstanding on December 31 was as follows:
1997 1996
Commercial $ 91,499 $102,756
Real Estate 4,459 2,986
Consumer 17,054 6,374
Standby Letters of Credit 4,878 6,236
----------------------------
$117,890 $118,352
============================
LEASE AGREEMENTS:
The Bank has entered into lease agreements covering its main office,
several branch locations, and equipment for various periods through
2011, with options to renew. Also, the Bank has the option to
purchase the main office facility before two optional renewal periods
at the fair market value in existence at that time.
Future minimum commitments under non-cancelable operating leases and
future estimated commitments under the electronic data processing
agreement are as follows:
1998 $1,722
1999 1,584
2000 1,563
2001 1,515
2002 1,444
thereafter 8,778
Rentals under operating leases and data processing costs amounted to
$2,555, $2,981, and $2,888 in 1997, 1996, and 1995, respectively.
Low Income Housing Project: In 1993, the Bank began investing in
low-income housing tax credit projects designed to provide affordable
housing for Ohio communities. The Bank has invested $924 to date and
has begun to realize tax credits and tax savings from the
investments. The Bank is committed to invest another $576 to the fund
over the next several years.
- --------------------------------------------------------------------------------
19. SIGNIFICANT CONCENTRATION OF CREDIT RISK
Most of the Bank's business activity is with customers located within
the state of Ohio. As of December 31, 1997, the Bank had a
concentration in commercial real estate loans totaling approximately
$206,000, approximately 69% of which were owner-occupied businesses,
including medical office buildings, retail and fast-food restaurants,
and automobile dealerships within the Bank's market area. Of the
$206,000 of commercial real estate loans, $2,821 or 1.4% were on
non-accrual status as of December 31, 1997.
45
47
REPORT OF INDEPENDENT AUDITORS
SECOND BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF SECOND BANCORP, INC.
We have audited the accompanying consolidated balance sheets of
Second Bancorp, Inc. and subsidiary as of December 31, 1997 and 1996,
and the related consolidated statements of income, shareholders'
equity, and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the
responsibility of the Corporation'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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position
of Second Bancorp, Inc. and subsidiary at December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Cleveland, Ohio
January 19, 1998
46
48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not Applicable.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Directors of the registrant information is incorporated herein by reference to
the definitive proxy statement for the annual meeting of shareholders to be held
May 12, 1998 (the "Proxy Statement"). Such Proxy Statement will be filed with
the Securities and Exchange Commission within 120 days of December 31, 1997.
Information regarding executive officers is included under item 4a hereof.
ITEM 11. EXECUTIVE COMPENSATION.
Executive compensation information is incorporated herein by reference to the
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Security ownership of certain beneficial owners and management information is
incorporated herein by reference to the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Certain relationships and related transactions information is incorporated
herein by reference to the Proxy Statement.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) The following consolidated financial statements of Second Bancorp,
Incorporated and subsidiary are incorporated herein by reference in Item 8:
Consolidated Balance Sheets - December 31, 1997 and 1996.
Consolidated Statements of Income - years ended December 31, 1997, 1996 and
1995.
Consolidated Statements of Shareholders' Equity - years ended December 31, 1997,
1996 and 1995.
Consolidated Statement of Cash Flows - years ended December 31, 1997, 1996 and
1995.
47
49
Notes to Consolidated Financial Statements.
Report of Independent Auditors.
(2) Schedules to the consolidated financial statements required by Article 9 of
Regulation S-X are not required under the related instructions or are
inapplicable, and therefore have been omitted.
(3) Listing of Exhibits. The exhibits listed on the accompanying Index to
Exhibits immediately following the financial statement schedules are filed as
part of, or incorporated by reference into, this report.
3.1(1) Articles of Incorporation of the Registrant.
3.2 Amendment to the Articles of Incorporation of the Registrant dated June 25, 1997.
3.3(1) Code of Regulations of the Registrant.
4.1(1) Amendment to the Articles of Incorporation of the Company, as amended, providing the terms of the
$1.50 Cumulative Convertible Preferred Stock, Series A-1.
10.1(1) Amended Stock Option Incentive Plan.
10.2(1) Form of Incentive Stock Option Agreement.
10.3(1) Stock Appreciation Rights Agreement by and between the Company and Alan G. Brant, dated April 1,
1987, as amended.
10.4 Form of Amendment to April 1, 1987 Stock Appreciation Rights Agreement by and between the Company
and Alan G. Brant, effective December 18, 1996.
10.5(1) Employment Agreement by and between the Company and Alan G.
Brant, dated April 1, 1985.
10.6(2) Amendments to Employment Agreement by and between the Company and Alan G. Brant, dated April 1,
1985.
10.7(1) Consulting Agreement by and between the Company and Alan G.
Brant, dated April 1, 1985.
10.8(2) Amendment to Consulting Agreement by and between the Company and Alan G. Brant, dated April 1,
1985.
10.9(2) Deferred Compensation Agreement between the Company and Alan G. Brant, dated
November 9,1995.
10.10(1) Lease Agreement between Arden Associates Limited Partnership and the Bank, dated October 1, 1979.
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10.11(2) Amendment to Lease Agreement between Arden Associates Limited Partnership and the Bank.
10.12(2) Form of Amended Management Severance Agreement with executive officers.
21 Subsidiaries of the registrant.
23.1 Consent of Ernst & Young.
(1) Incorporated by reference to the exhibit filed with the Company's annual
report on Form 10-K for the year ended December 31, 1994.
(2) Incorporated by reference to the exhibit filed with the Company's annual
report on Form 10-K for the year ended December 31, 1995.
(b) The Corporation did not file any reports on Form 8-K during the three
months ended December 31, 1997.
(c) Exhibits - The response to this portion of Item 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules - None.
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SIGNATURES
Pursuant to the requirements of section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SECOND BANCORP, INCORPORATED
/s/ DAVID L. KELLERMAN March 25, 1998
-------------------------------------------
David L. Kellerman, Treasurer (date)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
By: /s/ ALAN G. BRANT March 26, 1998
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A. G. Brant, Chairman and President (date)
By: /s/ DAVID L. KELLERMAN March 25, 1998
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D. L. Kellerman, Principal Financial (date)
Officer and Principal Accounting Officer
By: /s/ JOHN C. GIBSON SR. March 26, 1998
----------------------------------------------------------
John C. Gibson Sr., Director (date)
By: /s/ JOHN A. ANDERSON March 26, 1998
----------------------------------------------------------
John A. Anderson, Director (date)
By: /s/ ROBERT J. WEBSTER March 26, 1998
----------------------------------------------------------
Robert J. Webster, Director (date)
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