UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------- FORM 10-QSB |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 1999 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to __________ Commission File Number 0-24935 ------- SERVICE BANCORP, INC. --------------------- (Exact name of registrant as specified in its charter) Massachusetts 04-3430806 ------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification Number) 81 Main Street, Medway, Massachusetts 02053 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (508) 533-4343 ---------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable --------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last year.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practical date. At January 31, 2000, there were 1,620,430 shares of common stock outstanding, par value $0.01 per share. SERVICE BANCORP, INC. AND SUBSIDIARY FORM 10-QSB Index PART I FINANCIAL INFORMATION Page - ------ --------------------- ---- Item 1. Financial Statements Consolidated Balance Sheets as of December 31, 1999 and June 30, 1999 1 Consolidated Statements of Income for the three and six months ended December 31, 1999 and 1998 2 Consolidated Statements of Changes in Stockholders' Equity for the six months ended December 31, 1999 and 1998 3 Consolidated Statements of Cash Flows for the six months ended December 31, 1999 and 1998 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II OTHER INFORMATION Item 1. Legal Proceedings 19 Item 2. Changes in Securities 19 Item 3. Defaults upon Senior Securities 19 Item 4. Submission of Matters to a Vote of Security Holders 19 Item 5. Other Information 19 Item 6. Exhibits and Reports on Form 8-K 19 Signature Page 20 SERVICE BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except for per share amounts) December 31, June 30, ASSETS 1999 1999 ------------ --------- Cash and due from banks $ 10,985 $ 7,939 Short-term investments 957 5,451 --------- --------- Total cash and cash equivalents 11,942 13,390 --------- --------- Certificates of deposit 500 500 Securities available for sale 74,913 69,912 Federal Home Loan Bank stock, at cost 1,548 1,300 Loans 97,423 86,724 Less allowance for loan losses (804) (740) --------- --------- Loans, net 96,619 85,984 --------- --------- Banking premises and equipment, net 4,001 4,012 Accrued interest receivable 1,758 1,678 Other assets 2,265 1,382 --------- --------- Total assets $ 193,546 $ 178,158 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 149,162 $ 133,138 Federal Home Loan Bank advances 28,270 25,993 Other liabilities 1,062 2,548 --------- --------- Total liabilities 178,494 161,679 --------- --------- Stockholders' equity: Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued -- -- Common stock, $.01 par value; 12,000,000 shares authorized, 1,712,630 issued 17 17 Additional paid-in capital 7,437 7,444 Retained earnings 11,286 10,784 Accumulated other comprehensive loss (2,577) (1,182) Treasury stock, at cost - 68,500 shares at Dec. 31, 1999 and 10,000 shares at June 30, 1999 (560) (83) Unearned ESOP shares - 46,879 shares at Dec. 31, 1999 and 50,101 shares at June 30, 1999 (469) (501) Unearned RRP Stock - 10,800 shares at Dec. 31, 1999 (82) -- --------- --------- Total stockholders' equity 15,052 16,479 --------- --------- Total liabilities and stockholders' equity $ 193,546 $ 178,158 ========= ========= See accompanying notes to consolidated financial statements. 1 SERVICE BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except for per share amounts) Three Months Ended Six Months Ended December 31, December 31, ------------------------------------------------- 1999 1998 1999 1998 ---------- ---------- ---------- ---------- Interest and dividend income: Interest and fees on loans $ 1,839 $ 1,593 $ 3,597 $ 3,230 Interest and dividends on securities available for sale and FHLB stock 1,400 761 2,642 1,414 Interest on short-term investments and certificates of deposit 51 198 124 341 ---------- ---------- ---------- ---------- Total interest and dividend income 3,290 2,552 6,363 4,985 ---------- ---------- ---------- ---------- Interest expense: Interest on deposits 1,202 1,012 2,361 2,027 Interest on FHLB advances 373 191 684 385 ---------- ---------- ---------- ---------- Total interest expense 1,575 1,203 3,045 2,412 ---------- ---------- ---------- ---------- Net interest income 1,715 1,349 3,318 2,573 Provision for loan losses 35 25 80 50 ---------- ---------- ---------- ---------- Net interest income, after provision for loan losses 1,680 1,324 3,238 2,523 ---------- ---------- ---------- ---------- Other income: Customer service fees 196 155 376 278 Gain on sales of securities available for sale, net 214 247 233 320 Gain on sales of loans -- 13 -- 30 Miscellaneous 27 12 43 21 ---------- ---------- ---------- ---------- Total other income 437 427 652 649 ---------- ---------- ---------- ---------- Operating expenses: Salaries and benefits 811 742 1,567 1,307 Occupancy and equipment expenses 345 229 673 471 Data processing expenses 97 85 189 161 Professional fees 89 57 151 98 Advertising expenses 57 42 126 75 Other general and administrative expenses 195 172 393 294 ---------- ---------- ---------- ---------- Total operating expenses 1,594 1,327 3,099 2,406 ---------- ---------- ---------- ---------- Income before income taxes 523 424 791 766 Provision for income taxes 189 151 289 269 ---------- ---------- ---------- ---------- Net income $ 334 $ 273 $ 502 $ 497 ========== ========== ========== ========== Weighted average common shares outstanding during the period - Basic 1,606,478 N/A 1,624,743 N/A ========== ========== Diluted 1,606,478 N/A 1,626,678 N/A ========== ========== Earnings per common share (Basic and Diluted) $ 0.21 N/A $ 0.31 N/A ========== ========== See accompanying notes to consolidated financial statements. 2 SERVICE BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY SIX MONTHS ENDED DECEMBER 31, 1999 AND 1998 (Dollars in thousands) Accumulated Additional Other Unearned Unearned Common Paid-in Retained Comprehensive Treasury ESOP RRP Stock Capital Earnings Loss Stock Shares Stock Total -------- ---------- -------- -------- -------- -------- -------- -------- Balance at June 30, 1999 $ 17 $ 7,444 $ 10,784 ($ 1,182) ($ 83) ($ 501) $ -- $ 16,479 Common stock held by ESOP released and committed to be released (3,222 shares) -- (7) -- -- -- 32 -- 25 Comprehensive loss: Net Income -- -- 502 -- -- -- -- 502 Change in net unrealized loss on securities available for sale, net of tax and reclassification adjustment -- -- -- (1,395) -- -- -- (1,395) -------- Total comprehensive loss (893) -------- Purchase of treasury stock (58,500 shares) (477) -- -- (477) Purchase of RRP stock (10,800 shares) -- -- -- -- -- -- (82) (82) -------- -------- -------- -------- -------- -------- -------- -------- Balance at December 31, 1999 $ 17 $ 7,437 $ 11,286 ($ 2,577) ($ 560) ($ 469) ($ 82) $ 15,052 ======== ======== ======== ======== ======== ======== ======== ======== See accompanying notes to consolidated financial statements. 3 SERVICE BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY SIX MONTHS ENDED DECEMBER 31, 1999 AND 1998 (Concluded) (Dollars in thousands) Accumulated Additional Other Unearned Unearned Common Paid-in Retained Comprehensive Treasury ESOP RRP Stock Capital Earnings Loss Stock Shares Stock Total -------- ---------- -------- -------- -------- -------- -------- -------- Balance at June 30, 1998 $ -- $ -- $ 9,700 $ 423 $ -- $ -- $ -- $ 10,123 Net proceeds from sale of 17 7,449 -- -- -- -- -- 7,466 common stock Common stock acquired by ESOP (64,394) -- -- -- -- -- (644) -- (644) Common stock held by ESOP committed to be released (10,000 shares) -- -- -- -- -- 100 -- 100 Comprehensive income: Net income -- -- 497 -- -- -- -- 497 Change in net unrealized gain on securities available for sale net of tax and reclassification adjustment -- -- -- 19 -- -- -- 19 -------- Comprehensive income 516 -------- -------- -------- -------- ----- -------- ----- -------- Balance at December 31, 1998 $ 17 $ 7,449 $ 10,197 $ 442 $ -- ($ 544) $ -- $ 17,561 ======== ======== ======== ======== ===== ======== ===== ======== See accompanying notes to consolidated financial statements. 4 SERVICE BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Six Months Ended December 31, -------------------- 1999 1998 -------- -------- Cash flows from operating activities: Net income $ 502 $ 497 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for loan losses 80 50 Amortization of unearned loan income 29 -- Gain on sales of securities available for sale, net (233) (320) Amortization(accretion) of securities available for sale, net (60) 31 Depreciation and amortization expense 299 186 Decrease in accrued interest receivable (81) (272) Deferred tax benefit (78) (44) Loans originated for sale -- (3,016) Principal balance of loans sold -- 3,016 Other, net (1,060) 511 -------- -------- Net cash provided (used) by operating activities (602) 639 -------- -------- Cash flows from investing activities: Proceeds from sales of securities available for sale 3,346 1,195 Proceeds from maturities of and principal payments on securities available for sale 3,691 7,490 Purchase of securities available for sale (14,645) (28,979) Net decrease (increase) in loans (10,744) 9 Purchase of banking premises and equipment (288) (205) -------- -------- Net cash used by investing activities (18,640) (20,490) -------- -------- Cash flows from financing activities: Net increase in deposits 16,024 7,813 Proceeds from Federal Home Loan Bank advances 20,740 2,006 Repayment of Federal Home Loan Bank advances (18,463) (2,296) Release of common stock held by ESOP 25 100 Purchase of RRP stock (82) -- Increase in mortgagors' escrow deposits 27 -- Purchase of common stock for ESOP -- (644) Net proceeds from issuance of common stock -- 7,466 Purchase of treasury stock (477) -- -------- -------- Net cash provided by financing activities 17,794 14,445 -------- -------- Net change in cash and cash equivalents (1,448) (5,406) Cash and cash equivalents at beginning of period 13,390 16,383 -------- -------- Cash and cash equivalents at end of period $ 11,942 $ 10,977 ======== ======== Supplementary information: Interest paid on deposits $ 2,375 $ 2,029 Interest paid on Federal Home Loan Bank advances 643 392 Income taxes paid 376 318 Decrease in due from broker 521 1,053 See accompanying notes to consolidated financial statements. 5 SERVICE BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (1) Basis of Presentation and Consolidation The accompanying unaudited consolidated financial statements include the accounts of Service Bancorp, Inc. (the "Company") and its wholly-owned subsidiary, Summit Bank (the "Bank"), and the Bank's wholly-owned subsidiaries, Medway Securities Corp. and Franklin Village Security Corp., both of which engage solely in the purchase and sale of investment securities. All significant intercompany balances and transactions have been eliminated in consolidation. These financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and the instructions for Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for the entire year. (2) Reorganization and Stock Offering The Company is a Massachusetts corporation that was organized in August 1998 at the direction of the Board of Directors of the Bank and the Board of Trustees of Service Bancorp, MHC (the "MHC"), the mutual holding company parent of the Bank, for the purpose of owning all of the outstanding capital stock of the Bank. The Company offered for sale 47% of the shares of its outstanding common stock in a public offering to eligible depositors, employees, and members of the general public (the "Offering"). The remaining 53% of the Company's shares of common stock were issued to the MHC. The Offering was completed on October 7, 1998. Prior to that date, the Company had no assets or liabilities. Completion of the Offering resulted in the issuance of 1,712,630 shares of common stock, 907,694 shares of which were issued to the MHC and 804,936 shares of which were sold to eligible depositors, employees, and the general public at $10.00 per share. The Company began trading on the OTC Bulletin Board under the symbol "SERC" on October 7, 1998. Costs related to the Offering (primarily marketing fees paid to an underwriting firm, professional fees, registration fees, and printing and mailing costs) aggregated $569,000. These costs together with funds loaned to purchase shares for the Bank's Employee Stock Ownership Plan (the "ESOP") were deducted to arrive at net proceeds of $6.8 million. The Company contributed 50% of the net proceeds of the Offering to the Bank for general corporate use. On October 7, 1998, the Company loaned approximately $644,000 to the ESOP to fund its purchase of 64,394 shares of common stock of the Company. (3) Earnings per Share Earnings per share is based on the weighted average number of shares outstanding during the period beginning July 1, 1999 through December 31, 1999. The Company's "basic" and "diluted" earnings per share are identical as there were no material common stock equivalents during the periods covered by the report. Earnings per share is not presented for periods prior to January 1, 1999 since the Company completed its Offering on October 7, 1998 and, accordingly, such data would not be meaningful. 6 SERVICE BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (4) Commitments At December 31, 1999, the Company had outstanding commitments to originate loans of $4.1 million. Unused lines of credit available to customers amounted to $7.9 million, $7.5 million of which were equity lines of credit. (5) Securities Available for Sale The following table sets forth the Company's securities available for sale at the dates indicated. December 31, 1999 June 30, 1999 -------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ---- ----- ---- ----- (Dollars in thousands) Federal agency obligations $44,635 $42,624 $41,909 $40,870 Mortgage-backed securities 17,426 16,439 17,620 16,975 Other debt securities 14,205 13,480 9,441 9,216 ------- ------- ------- ------- Total debt securities 76,266 72,543 68,970 67,061 Marketable equity securities 2,581 2,370 2,746 2,851 ------- ------- ------- ------- Total securities $78,847 $74,913 $71,716 $69,912 ======= ======= ======= ======= (6) Loans The following table presents data relating to the composition of the Company's loan portfolio by type of loan at the dates indicated. December 31, 1999 June 30, 1999 ---------------------- --------------------- Amount Percent Amount Percent -------- ---------- -------- ---------- Real estate loans: (Dollars in thousands) Residential $ 56,428 57.90% $ 47,394 54.62% Commercial 23,451 24.06 20,981 24.18 Construction 3,006 3.08 4,974 5.73 -------- ---------- -------- ---------- Total real estate loans 82,885 85.05 73,349 84.54 Other loans: Consumer loans: Collateral 576 0.59 513 0.59 Home equity 4,951 5.08 4,591 5.29 Other 1,477 1.52 1,829 2.11 -------- ---------- -------- ---------- Total consumer loans 7,004 7.19 6,933 7.99 Commercial business loans 7,562 7.79 6,481 7.47 -------- ---------- -------- ---------- Total other loans 14,566 14.95 13,414 15.46 -------- ---------- -------- ---------- Total loans 97,451 100.00% 86,763 100.00% ========== ========== Net deferred loan fees (50) (51) Deferred premium 22 12 Allowance for loan losses (804) (740) -------- -------- Total loans, net $ 96,619 $ 85,984 ======== ======== 7 SERVICE BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (7) Deposits and Borrowed Funds The following tables indicate types and balances in deposit accounts at the dates indicated. December 31, 1999 June 30, 1999 -------------------- ---------------------- Amount Percent Amount Percent -------- --------- -------- --------- (Dollars in thousands) Demand $ 17,480 11.72% $ 12,524 9.41% NOW 19,247 12.90 21,082 15.83 Money market deposits 10,532 7.06 10,163 7.63 Regular and other savings 27,349 18.34 25,414 19.09 -------- --------- -------- --------- Total non-certificate accounts 74,608 50.02 69,183 51.96 Term certificates 74,554 49.98 63,955 48.04 -------- --------- -------- --------- Total deposits $149,162 100.00% $133,138 100.00% ======== ========= ======== ========= The following is a list of maturities for advances from the Federal Home Loan Bank of Boston ("the "FHLB") at the dates indicated. December 31, 1999 June 30, 1999 ----------------- ----------------- Amount Percent Amount Percent ------- ------- ------- ------- (Dollars are in thousands) Maturities less than one year $ 5,500 19.46% $ 5,218 20.07% Maturities greater than one year 22,770 80.54 20,775 79.93 ------- ------ ------- ------ Total borrowed funds $28,270 100.00% $25,993 100.00% ======= ====== ======= ====== 8 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation General This quarterly report on Form 10-QSB contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believe", "anticipates", "plans", "expects" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company's actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, the Bank's continued ability to originate quality loans, fluctuation in interest rates, real estate conditions in the Bank's lending areas, general and local economic conditions, the Bank's continued ability to attract and retain deposits, the Company's ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Comparison of Financial Condition at December 31, 1999 and June 30, 1999 Assets increased by $15.3 million, or 8.6%, from $178.2 million at June 30, 1999 to $193.5 million at December 31, 1999. The increase reflected management's growth strategy and was funded by the $16.0 million, or 12.0%, increase in total deposits since June 30, 1999, and a $2.3 million, or 8.8%, increase in total borrowings over this timeframe. The funds provided during the six months ended December 31, 1999 were invested in securities available for sale and net loans which increased $5.0 million, or 7.2%, and $10.6 million, or 12.4% respectively. The two investment categories which changed materially within the securities available for sale were federal agency obligations and other debt securities (primarily corporate debt) which increased $1.8 million, or 4.3%, and $4.3 million, or 46.3%, respectively. Short-term investments, consisting of overnight funds investments with large area financial institutions, decreased $4.5 million, or 82.4%, during the periods as the Bank deployed these funds into longer-term investment and loan portfolios. Net loans increased primarily because of a $9.0 million, or 19.1%, increase in residential real estate loans since June 30, 1999. This increase was primarily attributable to the purchase of three residential loan packages from other financial institutions in the Bank's geographical area totaling $7.7 million. In addition, commercial real estate loans and commercial secured and unsecured loans increased $2.5 million, or 11.8%, and $1.1 million, or 16.7%, respectively, since June 30, 1999. During this same timeframe construction loans and other consumer loans declined $2.0 million, or 39.6%, and $352,000, or 19.3%, respectively, while home equity loans increased $360,000, or 7.8%, and all other loan categories remained relatively the same. The emphasis during the first six months of the year had been to increase the residential loan portfolio which had declined over recent quarters due to the increase in loan payoffs and the increase of competition from other financial institutions. It is the Bank's continued objective to grow the residential fixed and variable products from loan originations within the Bank branch network. The purchase of loan packages from other financial institutions will be considered as the opportunities present themselves. The Bank considers many factors when deciding to purchase a loan package, including but not limited to the loan pricing, loan underwriting, interest rate risk, and the geographical location of the real estate securing the loans. In addition, the Bank continues to emphasize the growth in the commercial loan portfolio which generally provides higher yields than residential and consumer loans 9 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) as well as potentially improving the Bank's core deposit base. The Bank frequently receives commercial checking and money market accounts from the Bank's commercial borrowers. The increase of $16.0 million in deposits was primarily attributable to a $10.6 million, or 16.6%, increase in term certificates from June 30, 1999. Within non-certificate accounts, demand deposit accounts, regular savings, and money market deposits increased $5.0 million, or 39.6%, $1.9 million, or 7.6%, and $369,000, or 3.6%, respectively, while NOW accounts decreased $1.8 million, or 8.7% from June 30, 1999 to December 31, 1999. In addition, borrowings increased $2.3 million, or 8.8% since June 30, 1999, primarily to partially fund the purchase of residential loan packages mentioned earlier. Stockholders' equity decreased from $16.5 million, or 9.25% of total assets at June 30, 1999 to $15.1 million, or 7.78% of total assets at December 31, 1999. This decrease resulted primarily from an increase to $2.6 million in unrealized losses from $1.4 million in the Company's securities available for sale portfolio and the repurchase of 58,500 shares of the Company's common stock during the period for $477,000. In addition, the Company purchased 10,800 shares for its Recognition and Retention Plan for $82,000. These items were partially offset by the Company's earnings for the period. Non-Performing Assets and Allowance for Loan Losses The following indicates the non-performing assets and related allowance for loan loss ratios at the dates indicated. December 31, June 30, 1999 1999 ------------ ---------- (Dollars in thousands) Non-accrual loans: One-to-four family real estate loans $ 234 $ 317 Commercial loans 241 81 Consumer loans 12 -- ---------- ---------- Total non-accrual loans 487 398 Other real estate owned -- -- ---------- ---------- Total non-performing assets $ 487 $ 398 ========== ========== Allowance for loan losses $ 804 $ 740 ========== ========== 10 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) December 31, June 30, 1999 1999 ----------- -------- Allowance for loan losses as a percent of total loans, net 0.83% 0.86% ======= ======= Allowance for loan losses as a percent of non-accrual loans 165.09% 185.93% ======= ======= Non-accrual loans as a percent of total loans, net 0.50% 0.46% ======= ======= Non-performing assets as a percent of total assets 0.25% 0.22% ======= ======= During the six months ended December 31, 1999, the Bank added $80,000 to the loan loss provision due to the growth of the commercial loan portfolio which generally is considered to present a greater risk of loss than residential loans. During this period, there were $19,000 in loan charge-offs and $3,000 in recoveries from previously charged-off loans. While management believes that, based on information currently available, the allowance for loan losses is sufficient to cover losses in the Company's loan portfolio at this time, no assurances can be given that the level of the allowance will be sufficient to cover future loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. Comparison of Operating Results for the Three Months Ended December 31, 1999 and 1998 General Operating results are primarily dependent on the Bank's net interest income, which is the difference between the interest earned on the Bank's earning assets (short-term investments, loans, and investment securities) and the interest paid on deposits and borrowings. Operating results are also affected by provisions for loan losses, the level of income from non-interest sources such as fees and sales of investment securities and other assets, operating expenses and income taxes. Operating results are also significantly affected by general economic conditions, particularly changes in interest rates, as well as government policies and actions of regulatory authorities. Net income for the three months ended December 31, 1999 was $334,000 as compared to $273,000 for the three months ended December 31, 1998, an increase of $61,000, or 22.3%. This increase was primarily attributable to an increase of $366,000, or 27.1%, in net interest income, which was partially offset by an increase of $267,000, or 20.1%, in total operating expenses. In addition, customer service fees increased $41,000, or 26.5%, between periods, while net gains on the sales of securities and loans decreased $33,000 and $13,000 over the same period, respectively. 11 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) The Bank's interest rate spread (the difference between yields earned on earning assets and rates paid on deposits and borrowings) increased from 3.29% for the three months ended December 31, 1998 to 3.57% for the three months ended December 31, 1999. Interest rate margin (net interest income divided by average earning assets) increased from 3.84% to 3.96%. The interest rate spread and margin improved as the Bank increased its emphasis in the investment and loan portfolios in higher yielding, and in some cases longer maturing, corporate and federal agency bonds and commercial loans, respectively. The Bank opened a new retail branch in Milford, Massachusetts on January 13, 2000 and the Bank will explore opening additional retail branches in the future in locations with growth opportunities in both the retail and commercial markets. While core-based deposit growth will be emphasized, past experience indicates that such growth is achieved through a greater increase in higher-cost retail certificates than lower-cost core deposits. An increase in interest rates and continued competition from other financial institutions together with the aforementioned growth in retail certificates could cause future tightening in the interest rate spread. The interest rate spread and margin for the periods indicated are as follows: Three months ended December 31, ------------------- 1999 1998 ---- ---- Weighted average yield earned on: Short-term investments 5.34% 4.70% Investments 6.98% 6.20% Total loans, net 8.24% 8.53% ------- ------- All earning assets 7.60% 7.26% Weighted average rate paid on: Deposits 3.74% 3.79% Borrowed funds 5.35% 5.32% ------- ------- All interest-bearing liabilities 4.03% 3.97% ------- ------- Weighted average rate spread 3.57% 3.29% ======= ======= Net interest margin 3.96% 3.84% ======= ======= Earnings per share data for the three months ended December 31, 1999 was $0.21 for both "Basic" and "Diluted" calculations. Earnings per share is not presented for the three months ended December 31, 1998 because the Company became a publicly owned entity on October 7, 1998 and, accordingly, did not have shares outstanding throughout any of the periods presented prior to that date. 12 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) Interest and Dividend Income Total interest and dividend income increased by $738,000, or 28.9%, from $2.6 million for the three months ended December 31, 1998 to $3.3 million for the comparable period in 1999. This increase was primarily attributable to a $32.6 million, or 23.2%, increase in average earning assets between the two periods as well as a 34 basis point increase in the yield on earning assets between the two periods. The average balances in net loans increased $14.6 million, or 19.5%, while total loan yield declined by 29 basis points to 8.24%. This loan yield decline was primarily attributable to the fact that the residential loan portfolio has experienced larger than normal principal payoffs as borrowers sought to refinance their loans at lower rates. In addition, the yield on commercial loans declined due to lower market interest rates and the loan pricing of new commercial originations was impacted by the competitive pricing from other area financial institutions. The average investment portfolio balance increased $31.6 million or 64.5% over this same period and the portfolio yield improved by 78 basis points to 6.98%. The Bank decided to invest in federal agency and corporate obligations with longer maturities and higher yields in order to improve the interest rate margin while consistent with the interest rate profile objectives of the Asset-Liability ("ALCO") management process discussed below. In addition, the average balance in short-term investments declined $13.6 million, or 80.9%, between periods while the portfolio yield increased by 64 basis points to 5.34% between the two periods. Most of the funds within the short-term investment portfolio were obtained from the stock offering in October 1998 and from normal investment maturities and calls. The Bank reinvested these proceeds into longer-maturing and higher-yielding investments and loans. Interest Expense Interest expense on deposits increased $190,000, or 18.8%, from $1.0 million for the three months ended December 31, 1998, to $1.2 million for the three months ended December 31, 1999. This increase was attributable to a $21.9 million, or 20.5%, increase in average interest-bearing deposit balances between periods, which was partially offset by a reduction in deposit rates over the same period from 3.79% to 3.74%. The decrease in deposit interest rates was primarily due to the declining interest rate environment between the two periods. The Bank increased its use of borrowings from the FHLB as part of its management of interest rate risk. Average balances in these advances were $27.9 million during the three months ended December 31, 1999, an increase of $13.5 million, or 94.4% from the three months ended December 31, 1998. Over this same timeframe, average borrowing rates increased slightly from 5.32% to 5.35%. These borrowings were used in many cases to fund the purchase of investment securities where the yield and matching maturing terms favorably affected the net income and ALCO management performance of the Bank. Interest expense on FHLB advances increased $182,000, or 95.3%, from $191,000 for the three months ended December 31, 1998 to $373,000 for the three months ended December 31, 1999. 13 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) Other Income Total other income increased $10,000, or 2.3%, from $427,000 for the three months ended December 31, 1998 to $437,000 for the same period in 1999. This change was caused primarily by an increase of $41,000 in customer service fees between periods which was partially offset by decreases of $33,000, or 13.4%, and $13,000, or 100.0% in the net gains on the sales of securities amd loans, respectively. Customer service fees increased primarily due to increases in Visa Debit Card income, ATM surcharge income, and NOW account and NSF ("Non-sufficient funds") fees between periods. Operating Expense Total operating expense increased $267,000, or 20.1%, from $1.3 million for the three months ended December 31, 1998 to $1.6 million for the three months ended December 31, 1999. Salaries and benefits and occupancy and equipment expenses increased $69,000, or 9.3%, and $116,000, or 50.7%, respectively. No other individual expense category increased materially between periods. Much of the increase in operating expense was attributed to the Company's asset growth as management added staff and incurred costs to service the full range of retail and loan products added to the Bank's product lines. Despite the increase in operating expenses, the ratio of operating expenses to average assets decreased from 3.56% for the three months ended December 31, 1998 to 3.41% for the 1999 period. Income Taxes The effective income tax rate was 36.1% and 35.6% for the three months ended December 31, 1999 and 1998, respectively. The effective tax rates are below the statutory combined state and federal income tax rates because the Bank's two security corporations take advantage of the lower state tax rate afforded to these types of entities. Comparison of Operating Results for the Six Months Ended December 31, 1999 and 1998 General Net income for the six months ended December 31, 1999 was $502,000 as compared to $497,000 for the six months ended December 31, 1998, an increase of $5,000, or 1.0%. This increase was primarily attributable to an increase of $745,000, or 29.0%, in net interest income, which was partially offset by an increase of $693,000, or 28.8% in total operating expenses. In addition, customer service fees increased by $98,000, or 35.3%, primarily due to increases in Visa Debit card income, ATM surcharge income and NOW account and NSF fees. There were also decreases of $87,000, or 27.2%, and $30,000, or 100.0%, in net gains in the sales of securities and loans between periods, respectively. 14 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) The interest rate spread and margin for the periods indicated are as follows: Six months ended December 31, ------------------- 1999 1998 ---- ---- Weighted average yield earned on: Short-term investments 5.18% 5.07% Investments 6.88% 6.02% Total loans, net 8.19% 8.59% ------- ------- All earning assets 7.52% 7.35% Weighted average rate paid on: Deposits 3.74% 3.88% Borrowed funds 5.27% 5.34% ------- ------- All interest-bearing liabilities 4.00% 4.06% ------- ------- Weighted average rate spread 3.52% 3.29% ======= ======= Net interest margin 3.92% 3.79% ======= ======= Interest and Dividend Income Total interest and dividend income increased by $1.4 million, or 27.6%, from $5.0 million for the six months ended December 31, 1998 to $6.4 million for the comparable period in 1999. This increase was primarily attributable to a $33.6 million, or 24.8%, increase in average earning assets between the two periods and a 17 basis point increase in the yield on earning assets. The average balances in net loans increased $12.6 million, or 16.8%, while total loan yield declined by 40 basis points to 8.19%. This loan yield decline was primarily attributable to the fact that the residential loan portfolio has experienced larger than normal principal payoffs as borrowers sought to refinance their loans at lower rates. In addition, the yield on commercial loans declined due to lower market interest rates and the loan pricing of new commercial originations was impacted by the competitive pricing from other area financial institutions. The average investment portfolio balance increased $30.3 million, or 64.4%, over this same timeframe and its portfolio yield has improved by 86 basis points to 6.88%. The Bank decided to invest in federal agency and corporate obligations with longer maturities and higher yields in order to improve the interest rate margin while not consistent with the interest rate profile objectives of the Asset-Liability ("ALCO") management process discussed below. The average balance in short-term investments declined $9.3 million, or 69.0%, between periods while the portfolio yield increased by 11 basis points. Most of the funds within the short-term investment portfolio were obtained from the stock offering in October 1998 and from normal investment maturities and calls. The Bank reinvested these proceeds into longer-maturing and higher-yielding investments and loans. 15 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) Interest Expense Interest expense on deposits increased $334,000, or 16.5%, from $2.0 million for the six months ended December 31, 1998, to $2.4 million for the six months ended December 31, 1999. This increase was attributable to a $22.0 million, or 21.1%, increase in average interest-bearing deposit balances between periods, which was partially offset by a reduction in deposit rates over the same period from 3.88% to 3.74%. The decrease in deposit interest rates was primarily due to he declining interest rate environment between the two periods. The Bank increased its use of borrowings from the FHLB as part of its management of interest rate risk. Average balances in these advances were $26.0 million during the six months ended December 31, 1999, an increase of $11.5 million, or 80.0% from the six months ended December 31, 1998. Over this same timeframe, average borrowing rates declined from 5.34% to 5.27%. These borrowings were used in many cases to fund the purchase of investment securities where the yield and matching maturing terms favorably affected the net income and ALCO management performance of the Bank. Interest expense on FHLB advances increased $299,000, or 77.7%, from $385,000 for the six months ended December 31, 1998 to $684,000 for the six months ended December 31, 1999. Other Income Total other income increased $3,000, or 0.5%, from $649,000 for the six months ended December 31, 1998 to $652,000 for the same period in 1999. This change was caused primarily by an increase of $98,000 in customer service fees between periods which was partially offset by decreases of $87,000, or 27.2%, and $30,000, or 100%, in the net gains on the sales of securities and loans, respectively. Customer service fees improved primarily due to increases in Visa Debit Card income, ATM surcharge income, and NOW account and NSF fees between periods. Operating Expense Total operating expense increased $693,000, or 28.8%, from $2.4 million for the six months ended December 31, 1998 to $3.1 million for the six months ended December 31, 1999. Salaries and benefits and occupancy and equipment expenses increased $260,000, or 19.9%, and $202,000, or 42.9% respectively. No other individual expense category increased materially between periods. Much of the increase in operating expense was attributed to the Company's asset growth as management added staff and incurred costs to service the full range of retail and loan products added to the Bank's product lines. Accordingly, the ratio of operating expenses to average assets increased from 3.35% for the six months ended December 31, 1998 to 3.40% for the 1999 period. Income Taxes The effective income tax rate was 36.5% and 35.1% for the six months ended December 31, 1999 and 1998, respectively. The effective tax rates are below the statutory combined state and federal income tax rates because the Bank's two security corporations take advantage of the lower state tax rate afforded to these types of entities. 16 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) Asset/Liability Management A principal operating objective of the Bank is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. Since the Bank's principal interest-earning assets generally have longer terms to maturity than its primary source of funds, i.e., deposit liabilities, increases in general interest rates will generally result in an increase in the Bank's cost of funds before the yield on its asset portfolio adjusts upward. Financial institutions have generally sought to reduce their exposure to adverse changes in interest rates by attempting to achieve a closer match between the repricing periods of interest rate sensitive assets and liabilities. Such matching, however, is carefully monitored so as not to sacrifice net interest margin performance for the perfect matching of these interest rate sensitive instruments. The Bank has established an Asset/Liability Management Committee ("ALCO") made up of members of senior management to assess the asset/liability mix and recommend strategies that will enhance income while managing the Bank's vulnerability to changes in interest rate. This committee meets regularly to discuss interest rate conditions and potential product lines that would enhance the Bank's income performance. Certain strategies have been implemented to improve the match between interest rate sensitive assets and liabilities. These strategies include, but are not limited to: daily monitoring of the Bank's cash requirements, originating adjustable and fixed rate mortgage loans, both residential and commercial, for the Bank's own portfolio, managing the cost and structure of deposits, and generally using the matched borrowings to fund specific purchases of loan packages and large loan originations. Occasionally, management may choose to deviate from specific matching of maturities of assets and liabilities, if an attractive opportunity to enhance yield becomes available. Quarterly, ALCO modeling is performed with the assistance of an outside investment advisor which projects the Bank's financial performance over the next twenty four months using loan and deposit projections, projections of changes in interest rates, and anticipated changes in other income and operating expenses to reveal the full impact of the Bank's operating strategies on financial performance. The results of the ALCO process are reported to the Board at least on a quarterly basis. Liquidity and Capital Resources The Bank's primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales of loans and investments, maturities and early calls of investments, and funds provided from operations. While scheduled repayments of loans and maturities of investments are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Bank uses its liquidity resources primarily to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to pay operating expenses. From time to time, the Bank utilizes advances from the FHLB primarily in connection with its management of the interest rate sensitivity of its assets and liabilities. Total advances outstanding at December 31, 1999 amounted to $28.3 million. The Bank's ability to borrow from the FHLB is dependent upon the amount and type of collateral the Bank has to secure the loans. Such collateral consists of, but is not limited to, one-to-four family owner-occupied residential property, mortgage-backed securities guaranteed by the U.S. government or a government agency, and funds on deposit with 17 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Continued) the FHLB. As of December 31, 1999, the Bank's total borrowing capacity was $68.7 million. A major portion of the Bank's liquidity consists of cash and cash equivalents, short-term investments, U.S. Government and federal agency obligations, mortgage-backed securities, and other debt securities. The level of these assets is dependent upon the Bank's operating, lending, and financing activities during any given period. At December 31, 1999, the Bank had $4.1 million of outstanding commitments to originate loans. The Bank anticipates that it will have sufficient funds available to meet these commitments. Certificates of deposit, which are scheduled to mature in one year or less, totaled $66.2 million at December 31, 1999. Based upon historical experience, management believes that a significant portion of such deposits will remain with the Bank. At December 31, 1999, the Company and the Bank exceeded all regulatory capital requirements. Year 2000 ("Y2K") Disclosure The Company has devoted significant resources to minimize the risk of potential disruption due to Y2K issues. The Company has identified its mission-critical systems including its "core" data processing system for loans, deposits, and general ledger. In addition, the Company has identified and assessed its computer operating systems and network software; applications software; data processing hardware platforms such as personal computers and automated teller machines; third party interfaces; and environmental systems, including, but not limited to, climate control systems, sprinklers, and security systems. The Company's Y2K expenses since inception have been immaterial to its financial performance. No additional material expenses are anticipated. It is the intention of the Company to maintain normal business operations during the Year 2000 transition and beyond; including, for example, potential problems related to the first leap year of the new millennium: February 29, 2000. The Company has developed a Year 2000 Business Continuity and Contingency Plan in addition to the Company's Disaster Recovery Plan. Together, these plans help insure the continuity of daily operations in the event of a loss of essential resources due to Year 2000 induced failures. These plans describe individual contingency plans concerning specific software and hardware issues, operational plans for continuing operations, and specific policies and procedures that would be put in place upon the occurrence of a power outage, computer interruptions, telecommunications interruptions, natural disasters, etc. Such plans identify participants, processes and equipment that will be necessary to permit the Company to resume and continue operations until the problem is solved. Based upon our assessment of operations through February 11, 2000, we have not experienced any significant Year 2000 issues. In addition to expenses related to its own computer systems, the Company is aware of potential Year 2000 risks to third parties, including vendors, depositors, and borrowers and the possible adverse impact on the Company resulting from failures by these parties to adequately address the Year 2000 problem. As of February 11, 2000, we are not aware of any significant Year 2000 issues of vendors, borrowers, or depositors of the Company. In addition, the Company has analyzed the potential risks involved with its significant vendors, depositors, and borrowers, and anticipates them to have a relatively low level of risk of a major Year 2000 operating-related problem. 18 SERVICE BANCORP, INC. AND SUBSIDIARY ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation(Concluded) The preceding paragraphs include forward-looking statements that involve inherent risks and uncertainties. The actual costs of Year 2000 compliance and the impact of Year 2000 issues could differ materially from what is currently anticipated. Factors that might result in such differences include incomplete inventory and assessment results, higher than anticipated costs to update software and hardware, and vendors', customers, and other third parties' inability to effectively address the Year 2000 issues. PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which, in the aggregate, involved amounts which are believed by management to be immaterial to the financial condition and operations of the Company. Item 2. Changes in Securities Not applicable. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K Exhibit 27 EDGAR financial data schedule. There were no reports filed on Form 8-K. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SERVICE BANCORP, INC. Date: February 11, 2000 By: /s/ Eugene G. Stone -------------------------- Eugene G. Stone President and Chief Executive Officer Date: February 11, 2000 By: /s/ Warren W. Chase, Jr. -------------------------- Warren W. Chase, Jr. Senior Vice President and Treasurer 20