UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2001
or
|_| 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 0-27951
SECURITY FINANCIAL BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 35-2085053
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
9321 WICKER AVENUE, ST. JOHN, INDIANA 46373
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(Address of principal executive offices and ZIP code)
(219) 365-4344
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(Registrant's telephone number)
Not Applicable
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(Former name, former address, and former fiscal year, if changes
since last report)
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 [ ]
State the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: As of February 1, 2002,
Security Financial had 1,868,256 shares outstanding.
1
SECURITY FINANCIAL BANCORP, INC.
FORM 10-Q
INDEX
PAGE
PART I: FINANCIAL INFORMATION FOR SECURITY FINANCIAL
BANCORP, INC.
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at December 31, 2001
and June 30, 2001 3
Consolidated Statements of Income for the Three and Six
Months Ended December 31, 2001 and 2000 4 and 5
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended December 31, 2001 6
Consolidated Statements of Cash Flows for the Six Months
Ended December 31, 2001 and 2000 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis and Results
of Operations 10
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
SIGNATURES 21
2
PART I--FINANCIAL INFORMATION FOR
SECURITY FINANCIAL BANCORP, INC.
Item 1. FINANCIAL STATEMENTS.
---------------------
SECURITY FINANCIAL BANCORP, INC.
Consolidated Balance Sheets
December 31, 2001 and June 30, 2001
(Unaudited)
(Dollars in thousands, except per share)
December 31, June 30,
2001 2001
---- ----
Assets:
Cash and due from financial institutions $ 5,423 $ 4,938
Interest-bearing deposits in financial institutions 22,102 21,563
----------- -----------
Cash and cash equivalents 27,525 26,501
Securities available for sale 41,689 46,197
Loans held for sale 1,349 1,139
Loans receivable, net of allowance for loan losses of $1,522 at
December 31, 2001 and $1,486 at June 30, 2001 109,497 111,147
Federal Home Loan Bank stock 5,300 5,300
Cash surrender value of life insurance policies 6,337 6,164
Other real estate owned 156 197
Premises and equipment, net 5,186 5,414
Accrued interest receivable and other assets 1,957 2,858
----------- -----------
Total assets $ 198,996 $ 204,917
=========== ===========
Liabilities and Stockholders' Equity:
Liabilities:
Demand, NOW and money market deposits $ 20,100 $ 20,568
Savings 41,993 38,951
Time deposits 83,860 89,981
----------- -----------
Total deposits 145,953 149,500
Federal Home Loan Bank advances 15,000 15,000
Other borrowed funds 50 100
Advances from borrowers for taxes and insurance 237 428
Accrued interest and other liabilities 699 1,819
----------- -----------
Total liabilities 161,939 166,847
Stockholders' Equity:
Common stock 194 194
Additional paid-in capital 18,383 18,461
Unearned ESOP (1,344) (1,396)
Unearned stock awards (1,073) -
Treasury stock (345) -
Retained earnings, substantially restricted 21,274 20,940
Accumulated other comprehensive loss (32) (129)
----------- -----------
Total stockholders' equity 37,057 38,070
----------- -----------
Total liabilities and stockholders' equity $ 198,996 $ 204,917
=========== ===========
See accompanying notes to consolidated financial statements.
3
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Three Months Ended December 31, 2001 and 2000
(Unaudited)
(In thousands)
2001 2000
---- ----
Interest and dividend income:
Loans, including fees $ 2,123 $ 2,637
Securities 774 777
Other interest-earning assets 150 151
----------- -----------
Total interest income 3,047 3,565
Interest expense:
Deposits 1,215 1,645
Federal Home Loan Bank advances 193 -
Other borrowed funds 1 2
----------- -----------
Total interest expense 1,409 1,647
----------- -----------
Net interest income 1,638 1,918
Provision for loan losses 45 25
----------- -----------
Net interest income after provision for loan losses 1,593 1,893
Noninterest income:
Service charges and other fees 84 60
Loan charges and servicing fees 59 60
Gain on sale of loans from secondary market activities 70 12
Gain (loss) on sale of other real estate owned 8 12
Increase in cash surrender value on Bank-owned life insurance 87 -
Other 125 101
----------- -----------
Total noninterest income 433 245
Noninterest expense:
Compensation and benefits 826 852
Occupancy and equipment 295 358
Advertising and promotions 27 44
Data processing 63 103
Legal fees 394 45
Other 292 359
----------- -----------
Total noninterest expense 1,897 1,761
----------- -----------
Income before income taxes 129 377
Income taxes 16 106
----------- -----------
Net income $ 113 $ 271
=========== ===========
Earnings per share - basic $ .07 .15
Earnings per share - diluted $ .06 .15
Comprehensive income (loss) $ (177) $ 419
See accompanying notes to consolidated financial statements.
4
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Six Months Ended December 31, 2001 and 2000
(Unaudited)
(In thousands)
2001 2000
---- ----
Interest and dividend income:
Loans, including fees $ 4,335 $ 5,362
Securities 1,698 1,478
Other interest-earning assets 379 306
----------- -----------
Total interest income 6,412 7,146
Interest expense:
Deposits 2,639 3,242
Federal Home Loan Bank advance 386 -
Borrowed funds 2 2
----------- -----------
Total interest expense 3,027 3,244
----------- -----------
Net interest income 3,385 3,902
Provision for loan losses 90 90
----------- -----------
Net interest income after provision for loan losses 3,295 3,812
Noninterest income:
Service charges and other fees 161 121
Loan charges and servicing fees 115 119
Gain on sale of loans from secondary market activities 100 32
Gain (loss) on sale of other real estate owned 40 (28)
Increase in cash surrender value of life insurance 173 -
Other 240 207
----------- -----------
Total noninterest income 829 451
Noninterest expense:
Compensation and benefits 1,646 1,751
Occupancy and equipment 604 735
Advertising and promotions 57 120
Data processing 155 208
Legal fees 630 88
Other 397 615
----------- -----------
Total noninterest expense 3,689 3,517
----------- -----------
Income before income taxes 435 746
Income taxes 101 106
----------- -----------
Net income $ 334 $ 640
=========== ===========
Earnings per share - basic $ .19 $ .36
Earnings per share - diluted $ .19 $ .36
Comprehensive income $ 431 $ 804
See accompanying notes to consolidated financial statements.
5
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statement of Changes in Stockholders' Equity
For the Six Months Ended December 31, 2001
(Unaudited)
(In thousands)
Accumulated
Other Total
Additional Unearned Comprehensive Stock-
Common Paid-In Unearned Stock Retained Income Treasury holders'
Stock Capital Esop Awards Earnings (Loss) Stock Equity
----- ------- ---- ------ -------- ------ ----- ------
Balance at July 1, 2001 $ 194 $ 18,461 $ (1,396) $ - $ 20,940 $ (129) $ - $ 38,070
ESOP shares earned - 47 52 - - - - 99
Stock awards issued
- 69,834 shares - (125) - (1,187) - - 1,312 -
Stock awards earned - - - 114 - - - 114
Purchase 88,038 shares
of treasury stock - - - - - - (1,657) (1,657)
Comprehensive income:
Net income - - - - 334 - - 334
Change in unrealized gain
on securities available-
for-sale - - - - - 97 - 97
Total comprehensive --------
income 431
--------- --------- --------- --------- --------- --------- -------- --------
Balance at December 31,
2001 $ 194 $ 18,383 $ (1,344) $ (1,073) $ 21,274 $ (32) $ (345) $ 37,057
========= ========= ========= ========= ========= ========= ======== ==========
See accompanying notes to consolidated financial statements.
6
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Cash Flows
For Six Months Ended December 31, 2001 and 2000
(Unaudited)
(In thousands)
2001 2000
---- ----
Cash flows from operating activities:
Net income $ 334 $ 640
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation 269 319
Provision for loan losses 90 90
(Gain) loss on other real estate owned (40) 28
Origination and purchase of loans held for sale (8,169) (3,805)
Proceeds from sales of loans held for sale 8,059 3,883
Gain on sale of loans for secondary market (100) (32)
ESOP expense 99 83
Stock award expenses 114 -
Accretion of discount on securities (160) (188)
Increase in cash surrender value of life insurance (173) -
Change in other assets 836 (147)
Change in other liabilities (1,120) (201)
----------- -----------
Net cash from operating activities 39 670
Cash flows from investing activities:
Proceeds from maturities and calls of securities available for sale 24,202 16,940
Principal payments on securities available for sale 1,140 610
Purchase of securities available for sale (20,512) (28,240)
Change in loans 1,499 8,228
Investment in life insurance policies - (3,000)
Change in premises and equipment, net (41) (462)
Proceeds from sale of other real estate 142 267
----------- -----------
Net cash from investing activities 6,430 (5,657)
Cash flows from financing activities:
Change in deposits (3,547) (1,544)
Change in advance payments by borrowers for taxes and insurance (191) (113)
Proceeds from other borrowed funds - 150
Repayments of other borrowed funds (50) -
Change in Federal Home Loan Bank line of credit - 2,313
Purchase of treasury stock (1,657) -
----------- -----------
Net cash for financing activities (5,445) 806
----------- -----------
Net increase (decrease) in cash and cash equivalents 1,024 (4,181)
Cash and cash equivalents at beginning of period 26,501 9,854
----------- -----------
Cash and cash equivalents at end of period $ 27,525 $ 5,673
=========== ===========
Supplemental disclosures of cash flow information: Cash paid during the period
for:
Interest $ 3,057 $ 3,216
Taxes 400 -
Transfer from loans to foreclosed real estate 61 43
See accompanying notes to consolidated financial statements.
7
SECURITY FINANCIAL BANCORP, INC.
Notes to Consolidated Financial Statements
(1) Organization
Security Financial Bancorp Inc. ("Security Financial" or "the Company")
was incorporated under the laws of Delaware in September 1999 for the purpose of
serving as the holding company of Security Federal Bank & Trust ("Security
Federal" or "the Bank") as part of Security Federal's conversion from the mutual
to stock form of organization. The conversion, completed on January 5, 2000,
resulted in Security Financial issuing a total of 1,938,460 shares of its common
stock, par value $.01 per share, at a price of $10 per share. Prior to the
conversion, Security Financial had not engaged in any material operations and
had no assets or income. Security Financial is currently a savings and loan
holding company and is subject to regulation by the Office of Thrift Supervision
and the Securities and Exchange Commission. Prior to the conversion, Security
Federal was known as Security Federal Bank, a Federal Savings Bank.
(2) Accounting Principles
The accompanying unaudited financial statements of Security Financial,
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, the financial statements do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of a normal recurring nature) considered necessary for a
fair presentation have been included. Operating results for the three and six
months ended December 31, 2001 are not necessarily indicative of the results
that may be expected for the current fiscal year.
These financial statements should be read in conjunction with the
consolidated financial statements included in Security Financial's June 30, 2001
Form 10-KSB.
(3) Earnings Per Share
The following table presents a reconciliation of the components used to
compute basic and diluted earnings per share for the quarters ended December 31,
2001 and 2000:
2001 2000
---- ----
Basic
Net income $ 113 $ 271
=========== ===========
Weighted average common shares outstanding 1,721 1,791
=========== ===========
Basic earnings per common share $ .07 $ .15
=========== ===========
8
2001 2000
---- ----
Diluted
Net income $ 113 $ 271
=========== ===========
Weighted average common shares outstanding 1,721 1,791
Diluted effect of stock options and stock awards 24 -
----------- -----------
Diluted average common shares 1,745 1,791
=========== ===========
Diluted earnings per share $ .06 $ .15
=========== ===========
The following table presents a reconciliation of the components used to
compute basic and diluted earnings per share for the six months ended December
31, 2001 and 2000:
2001 2000
---- ----
Basic
Net income $ 334 $ 640
=========== ===========
Weighted average common shares outstanding 1,744 1,791
=========== ===========
Basic earnings per common share $ .19 $ .36
=========== ===========
Diluted
Net income $ 334 $ 640
=========== ===========
Weighted average common shares outstanding 1,744 1,791
Diluted effect of stock options and stock awards 20 -
----------- -----------
Diluted average common shares 1,764 1,791
=========== ===========
Diluted earnings per share $ .19 $ .36
=========== ===========
At December 31, 2001, options to purchase 17,445 shares and 3,000
unearned stock awards were not included in the computation of diluted earnings
per share because the options' exercise price and the stock awards' grant price
were greater than the average market price of the common stock for the quarter
and six-month period and were therefore antidilutive.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS.
The following presents management's discussion and analysis of the results
of operations and financial condition of Security Financial as of the dates and
for the periods indicated. This discussion should be read in conjunction with
the Company's consolidated financial statements and the notes thereto and other
financial data appearing elsewhere in the annual report.
Forward-Looking Statements
This Interim Report contains certain forward-looking statements, which
are based on certain assumptions and describe future plans, strategies, and
expectations of the Company. These forward-looking statements are generally
identified by use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project," or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors that could have a material adverse effect on the operations
of the Company and the subsidiaries include, but are not limited to, changes in
interest rates, general economic conditions, legislative/regulatory changes,
monetary and fiscal policies of the U.S. government including policies of the
U.S. Treasury and the Federal Reserve Board, the quality or composition of the
loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area, and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements, and undue reliance should
not be placed on such statements. The Company does not undertake--and
specifically disclaims any obligation--to publicly release the result of any
revisions that may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
General
The Company is engaged primarily in attracting deposits from the
general public and using such deposits to originate loans secured by
one-to-four-family residential real estate properties, commercial real estate
properties located in its market area and, to a lesser extent, consumer and
other loans primarily in its market areas and to acquire securities. The
Company's revenues are derived principally from interest earned on loans and
securities, gains from sales of first mortgage loans in the secondary market,
and fees from other banking-related services. The operations of the Company are
influenced significantly by general economic conditions and by policies of
financial institution regulatory agencies, primarily the Office of Thrift
Supervision and the Federal Deposit Insurance Corporation. The Company's cost of
funds is influenced by interest rates on competing investments and general
market interest rates. Lending activities and mortgage loan sales volumes are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financings may be
offered.
The Company's net interest income is dependent primarily upon the
difference or spread between the average yield earned on loans receivable and
securities and the average rate paid on deposits, as well as the relative
amounts of such assets and liabilities. The Company, like other thrift
institutions, is subject to interest rate risk to the degree that its
interest-bearing
10
liabilities mature or reprice at different times or on a different basis than
its interest-earning assets.
The following analysis discusses changes in the financial condition and
results of operations at and for the three and six months ended December 31,
2001 and should be read in conjunction with Security Financial's unaudited
consolidated financial statements and the notes thereto, appearing in Part I,
Item 1 of this document.
Comparison of Financial Condition at December 31, 2001 and June 30, 2001.
Total assets decreased by $5.9 million to $199.0 million at December 31,
2001 from $204.9 million at June 30, 2001.
Total loans declined to $109.5 million at December 31, 2001 from $111.1
million at June 30, 2001, or 1.4%. Residential mortgage loan balances declined
due to loans being paid down or refinanced in the lower interest rate
environment. These balances were not replaced by new originations because the
Bank sells the majority of the fixed rate long-term mortgages that it
originates. Consumer loans continued to decline as loans from the Bank's
discontinued indirect lending program pay down.
Total deposits decreased to $146.0 million at December 31, 2001, from
$149.5 million at June 30, 2001, a decline of 2.3% as management let
higher-priced funding sources run off. Time deposits decreased by $6.1 million,
savings accounts increased by $3.0 million and other deposits decreased by
$400,000.
Total stockholders' equity at December 31, 2001 was $37.1 million compared
to $38.1 million at June 30, 2001. The decrease resulted from the purchase of
treasury stock totaling $1.7 million. Of the treasury stock purchased $1.3
million was allocated to the Company's Stock-Based Incentive Plan. This was
partially offset by Security Financial's net income for the six months ended
December 31, 2001 of $334,000; and a $97,000 increase in the fair value of
securities available for sale, net of taxes.
Comparison of Operating Results for the Three Months Ended December 31, 2001 and
2000
General. Net income for the three-month period ended December 31, 2001
was $113,000 compared to net income of $271,000 for the comparable period in
2000, a decrease of $158,000. The decrease is primarily attributable to legal
fees and other expenses incurred by the Company related to a shareholder lawsuit
in the current period and a $280,000 decrease in net interest income. These
declines were partially offset by a $188,000 increase in noninterest income and
a $90,000 decrease in income tax expense.
Interest Income. Interest income for the quarter ended December 31, 2001
was $3.0 million compared to $3.6 million for the quarter ended December 31,
2000, a decrease of $518,000, or 14.5%. The decrease was primarily attributable
to a significant decrease in the yield earned on our interest earning assets
which decreased to 6.61% for the three-month period ended December 31, 2001 from
8.09% for the same period in 2000. The decrease in interest income due to
changes in rate was offset slightly by an increase in the average balance of
interest earning
11
assets to $184.5 million for the three months ended December 31, 2001 from
$176.3 million for the same period in 2000. The yield earned on the Company's
cash balances decreased approximately 360 basis points for the compared periods.
Interest Expense. Interest expense for the quarter ended December 31,
2001 was $1.4 million compared to $1.6 million for the quarter ended December
31, 2000, a decrease of $238,000 or 14.5%. The decrease was primarily
attributable to a significant decrease in the rates paid on interest bearing
liabilities. The Company's interest expense to average interest-earning assets
decreased to 3.05% for the three-month period ended December 31, 2001 from 3.74%
for the same period in 2000. Our cost of funds decreased to 3.53% for the three
months ended December 31, 2001 from 4.50% for the three months ended December
31, 2000, reflecting a general decrease in interest rates in the quarter ended
December 31, 2001. The decrease in interest expense due to changes in rate was
offset partially by an increase in the average balance of interest-bearing
liabilities to $159.8 million for the quarter ended December 31, 2001 from
$146.5 million during the quarter ended December 31, 2000. The increase in the
average balance of interest-bearing liabilities was due primarily to an increase
in advances from the Federal Home Loan Bank of Indianapolis in 2001.
Net Interest Income. Net interest income decreased to $1.6 million for
the three-month period ended December 31, 2001 from $1.9 million, a decrease of
$280,000, or 14.6%. The net interest margin decreased to 3.55% from 4.35% during
the same periods. The decrease in the net interest margin is attributable
primarily to a significant decrease in market interest rates, particularly on
the short end of the yield curve.
Provision for Loan Losses. We establish provisions for loan losses, which
are charged to operations, at a level management believes is appropriate to
absorb probable incurred credit losses in the loan portfolio. In evaluating the
level of the allowance for loan losses, we evaluate larger commercial,
commercial real estate, and construction loans individually for impairment based
upon collateral values, adverse situations that may affect the borrowers ability
to repay, and other factors. Smaller balance homogeneous mortgaged consumer
loans are evaluated independently based upon loss factors derived from
historical loss experience, peer group information, and similar factors adjusted
for current economic conditions. This evaluation is inherently subjective as it
requires estimates that are susceptible to significant revision as more
information becomes available or as future events change. Based on our
evaluation of these factors, management made provisions of $45,000 and $25,000
for the three months ended December 31, 2001 and 2000, respectively. We used the
same methodology and generally similar assumptions in assessing the adequacy of
the allowance for both periods. The provision for the three months ended
December 31, 2001 reflects an increase in loans classified as substandard from
$2.3 million at September 30, 2001 to $3.0 million at December 31, 2001. The
allowance for loan losses was $1.5 million, or 1.37%, of loans outstanding at
December 30, 2001, as compared with $1.5 million, or 1.32%, of loans outstanding
at June 30, 2001. The level of the allowance is based on estimates and the
ultimate losses may vary from the estimates. Management assesses the allowance
for loan losses on a monthly basis and makes provisions for loan losses as
necessary in order to maintain the adequacy of the allowance. While management
uses available information to recognize losses on loans, future loan loss
provisions may be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review the allowance for
12
loan losses and may require us to recognize additional provisions based on their
judgment of information available to them at the time of their examination. The
allowance for loan losses as of December 31, 2001 is maintained at a level that
represents management's best estimate of inherent losses in the loan portfolio,
and such losses were both probable and reasonably estimable.
Noninterest Income. Noninterest income was $433,000 for the three months
ended December 31, 2001 compared to $245,000 for the three-month period ended
December 31, 2000, an increase of $188,000, or 76.7%. The increase is primarily
attributable to $87,000 of income on bank owned life insurance that was
purchased during the 2nd and 3rd quarters of fiscal 2001, a $58,000 increase in
gains on the sale of mortgage loans from secondary market activities and an
increase in service charges on deposit accounts of $24,000.
Noninterest Expense. Noninterest expense for the quarter ended December
31, 2001 was $1.9 million compared to $1.8 million for the quarter ended
December 31, 2000, an increase of $136,000, or 7.7%. The increase was primarily
attributable to legal fees of $394,000 for the quarter ended December 31, 2001
compared to $45,000 for the quarter ended December 31, 2000. Of the $394,000 in
legal fees, $285,000 will be paid to PL Capital LLC in a one-time settlement of
their legal fees associated with the lawsuit styled PL CAPITAL LLC ET AL. V.
BONAVENTURA, ET AL. Reimbursement of a portion of the legal fees is expected to
be received from the Company's insurance provider. The increase was partially
offset by a $63,000 reduction in occupancy and equipment expense, a $40,000
decrease in data processing expense, and a $26,000 reduction in compensation and
benefits expense.
Income Taxes. Tax net operating loss carry forwards were fully utilized
during the quarter ended December 31, 2000, causing the Company to begin
recognizing income tax expense. The Company recorded income tax expense of
$16,000 for the three months ended December 31, 2001. This compares to $106,000
of income tax expense for the quarter ended December 31, 2000.
Comparison of Operating Results for the Six Months Ended December 31, 2001 and
2000
General. Net income for the six-month period ended December 31, 2001 was
$334,000 compared to net income of $640,000 for the comparable period in 2000, a
decrease of $306,000. The decrease is primarily attributable to legal fees and
other expenses incurred by the Company related to a shareholder lawsuit in the
current period.
Interest Income. Interest income for the six months ended December 31,
2001 was $6.4 million compared to $7.1 million for the six months ended December
31, 2000, a decrease of $734,000, or 10.3%. The decrease was primarily
attributable to a significant decrease in the yield earned on our interest
earning assets which decreased to 6.91% for the six-month period ended December
31, 2001 from 8.08% for the same period in 2000. The decrease in interest income
due to changes in rate was offset slightly by an increase in the average balance
of interest earning assets to $185.8 million for the six months ended December
31, 2001 from $176.8 million for the same period in 2000. The yield earned on
the Company's cash balances decreased approximately 296 basis points for the
compared periods.
13
Interest Expense. Interest expense for the six months ended December 31,
2001 was $3.0 million compared to $3.2 million for the six months ended December
31, 2000, a decrease of $217,000 or 6.7%. The decrease was primarily
attributable to a significant decrease in the rate paid on interest bearing
liabilities. The Company's interest expense to average interest-earning assets
decreased to 3.26% for the six-month period ended December 31, 2001 from 3.67%
for the same period in 2000. Our cost of funds decreased to 3.69% for the six
months ended December 31, 2001 from 4.42% for the six months ended December 31,
2000, reflecting a general decrease in interest rates in the six-month period
ended December 31, 2001. The decrease in interest expense due to changes in rate
was offset partially by an increase in the average balance of interest-bearing
liabilities to $163.9 million for the six months ended December 31, 2001 from
$146.9 million for the six months ended December 31, 2000. The increase in the
average balance of interest-bearing liabilities was due primarily to an increase
in advances from the Federal Home Loan Bank of Indianapolis in 2001.
Net Interest Income. Net interest income decreased to $3.4 million for
the six-month period ended December 31, 2001 from $3.9 million, a decrease of
$517,000, or 13.3%. The net interest margin decreased to 3.65% from 4.41% during
the same periods. The decrease in the net interest margin is attributable
primarily to a significant decrease in market interest rates, particularly on
the short end of the yield curve.
Provision for Loan Losses. We establish provisions for loan losses, which
are charged to operations, at a level management believes is appropriate to
absorb probable incurred credit losses in the loan portfolio. In evaluating the
level of the allowance for loan losses, management considers historical loss
experience, the types of loans and the amount of loans in the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral, peer group information, and prevailing
economic conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available or as future events change. Based on our evaluation of these
factors, management made provisions of $90,000 for the six months ended June 30,
2001 and 2000. We used the same methodology and generally similar assumptions in
assessing the adequacy of the allowance for both periods. The provision for the
six months ended December 31, 2001 reflects an increase in loans classified as
substandard from $2.1 million at June 30, 2001 to $3.0 million at December 31,
2001.
Noninterest Income. Noninterest income was $829,000 for the six months
ended December 31, 2001 compared to $451,000 for the six months ended December
31, 2000, an increase of $378,000, or 83.8%. The increase is primarily
attributable to $173,000 of income on bank owned life insurance that was
purchased during the 2nd and 3rd quarters of fiscal 2001, an increase in gains
on the sale of mortgage loans from secondary market activities of $68,000, gains
on the sale of other real estate owned of $40,000 in the current period versus a
$28,000 loss in the comparable period and an increase in service charges on
deposit accounts of $40,000.
Noninterest Expense. Noninterest expense for the six months ended
December 31, 2001 was $3.7 million compared to $3.5 million for the six months
ended December 31, 2000, an increase of $172,000, or 4.9%. The increase is
primarily attributable to a $542,000 increase in legal fees, a majority of which
related to one-time costs associated with a shareholder lawsuit for the compared
periods. Reimbursement of a portion of the legal fees is expected to be
14
received from the Company's insurance provider. The increase was partially
offset by a $131,000 reduction in occupancy and equipment expense, a $105,000
reduction in compensation and benefits expense, a $61,000 reduction in
advertising and promotion expense and a $53,000 decrease in data processing
expense.
Income Taxes. Tax net operating loss carry forwards were fully utilized
during the quarter ended December 31, 2000, causing the Company to begin
recognizing income tax expense. The Company recorded income tax expense of
$101,000 for the six months ended December 31, 2001. This compares to $106,000
of income tax expense for the six months ended December 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits and proceeds from
principal and interest payments on loans and mortgage-backed securities. While
maturities and scheduled amortization of loans and securities are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions, and competition. The Company
generally manages the pricing of its deposits to be competitive and to increase
core deposit relationships.
The Company's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities, and
financing activities. Cash flows provided by operating activities were $81,000
and $670,000 for the six months ended December 31, 2001 and 2000, respectively.
Net cash from investing activities consisted primarily of disbursements for loan
originations and the purchase of securities, offset by principal collections on
loans and proceeds from maturation and calls of securities. Net cash from
financing activities consisted primarily of the activity in deposit and escrow
accounts and the purchase of treasury stock.
The Company's most liquid assets are cash and cash equivalents. The
levels of these assets are dependent on the Company's operating, financing,
lending, and investing activities during any given period. At December 31, 2001,
cash and cash equivalents totaled $27.5 million. The Company has other sources
of liquidity if a need for additional funds arises, including securities
maturing within one year and the repayment of loans. The Company may also
utilize the sale of securities available for sale, federal funds purchased, and
Federal Home Loan Bank advances as a source of funds. At December 31, 2001, the
Company had the ability to borrow a total of approximately $29.7 million from
the Federal Home Loan Bank of Indianapolis. On that date, the Company had $15.0
million of outstanding advances.
At December 31, 2001, the Company had outstanding commitments to
originate loans of $4.8 million. Of this total, $1.6 million had fixed rates and
$3.2 million had not locked in a rate yet. These loans are to be secured by
properties located in its market area. The Company anticipates that it will have
sufficient funds available to meet its current loan commitments. Loan
commitments have, in recent periods, been funded through liquidity or through
FHLB borrowings. Certificates of deposit that are scheduled to mature in one
year or less from December 31, 2001 totaled $69.0 million. Management believes,
based on past experience, that a significant portion of such deposits will
remain with the Company. Based on the foregoing, in addition to the Company's
high level of core deposits and capital, the Company considers its
15
liquidity and capital resources sufficient to meet its outstanding short-term
and long-term needs.
Liquidity management is both a daily and long-term responsibility of
management. The Company adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquid assets are invested generally in interest-earning overnight
deposits and short- and intermediate-term U.S. government and agency obligations
and mortgage-backed securities of short duration. If the Company requires funds
beyond its ability to generate them internally, it has additional borrowing
capacity with the Federal Home Loan Bank of Indianapolis.
Security Federal's actual and required capital amounts and rates are
presented below (in thousands).
Requirement
to Be Well
Requirement Capitalized Under
for Capital Prompt Corrective
Adequacy Action
Actual Purposes Provisions
------ -------- ----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2001:
Total capital
(to risk-
weighted
assets) $ 30,144 26.1% $ 9,241 8.0% $ 11,551 10.0%
Tier 1 capital
(to risk-
weighted
assets) 28,807 24.9 4,621 4.0 6,931 6.0
Core capital
(to adjusted
assets) 28,807 14.9 7,760 4.0 9,700 5.0
As of June 30, 2001:
Total capital
(to risk-
weighted
assets) $ 29,129 25.2% $ 9,250 8.0% $ 11,563 10.0%
Tier 1 capital
(to risk-
weighted
assets) 27,923 24.1 4,625 4.0 6,938 6.0
Core capital
(to adjusted
assets) 27,923 13.9 8,026 4.0 10,032 5.0
16
IMPACT OF ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards (SFAS) No. 141, BUSINESS
COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. In July
2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141,
BUSINESS COMBINATIONS, which requires that all business combinations be
accounted for under a single method, the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS No. 141 requires that
the purchase method be used for business combinations initiated after June 30,
2001. Since this accounting standard applies to business combinations initiated
after June 30, 2001, it will have no effect on the Company's financial
statements unless the Company enters into a business combination transaction.
In July 2001, the FASB also issued SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS, which requires that goodwill no longer be amortized to
earnings but instead be reviewed for impairment. The amortization of goodwill
ceases upon adoption of SFAS No. 142, which for most companies will be January
1, 2002. This pronouncement will not have a material effect on the Company's
financial statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
In an attempt to manage its exposure to changes in interest rates,
management monitors Security Federal's interest rate risk. The Board of
Directors reviews at least quarterly Security Federal's interest rate risk
position and profitability. The Board of Directors also reviews Security
Federal's portfolio, formulates investment strategies, and oversees the timing
and implementation of transactions to ensure attainment of Security Federal's
objectives in the most effective manner. In addition, the Board reviews on a
quarterly basis Security Federal's asset/liability position, including
simulations of the effect on Security Federal's capital of various interest rate
scenarios.
In managing its asset/liability mix, Security Federal, depending on the
relationship between long- and short-term interest rates, market conditions, and
consumer preference, often places more emphasis on managing short-term net
interest margin than on better matching the interest rate sensitivity of its
assets and liabilities in an effort to enhance net interest income. Management
believes that the increased net interest income resulting from a mismatch in the
maturity of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide high enough returns to justify the increased
exposure to sudden and unexpected increases in interest rates.
The Board has taken a number of steps to manage Security Federal's
vulnerability to changes in interest rates. First, Security Federal uses
customer service and marketing efforts to increase Security Federal's
noncertificate accounts. At December 31, 2001, $62.1 million, or 43%, of
Security Federal's deposits consisted of demand, NOW, money market accounts, and
savings. Security Federal believes that these accounts represent "core"
deposits, which are generally somewhat less interest rate sensitive than other
types of deposit accounts. Second, while Security Federal continues to originate
30-year, fixed-rate residential loans, all such loans are sold in the secondary
market. Currently, over 45% of Security Federal's loans carry adjustable
17
interest rates. Finally, Security Federal has focused a significant portion of
its investment activities on securities with terms of five years or less. At
December 31, 2001, $5.4 million, or 13%, of Security Federal's securities had
terms to maturity of five years or less based on their carrying value in
addition to Security Federal's mortgage-backed securities, which provide for
regular principal repayments.
The Office of Thrift Supervision provides the Company with the
information presented in the following table. It presents the change in the
Company's net portfolio value at September 30, 2001 that would occur upon an
immediate change in interest rates based on Office of Thrift Supervision
assumptions, but without effect to any steps that management might take to
counteract that change.
Change in NPV as % of
Interest Rates Portfolio Value of Assets
-------------------------
in Basis Points Net Portfolio Value NPV Basis Point
-------------------
(Rate Shock) Amount $ Change % Change Ratio Change
------------ ------ -------- -------- ----- ------
(Dollars in thousands)
300 $ 27,297 (8,222) (23.2)% 13.84% -326 bp
200 29,999 (5,521) (15.5) 14.95 -215 bp
100 32,769 (2,750) (7.7) 16.05 -105 bp
Static 35,519 - - 17.10 -
(100) 35,611 92 .3 17.06 -4 bp
(200) 36,001 482 1.4 17.13 +3 bp
The Office of Thrift Supervision uses certain assumptions in assessing
the interest rate risk of savings associations. These assumptions relate to
interest rates, loan prepayment rates, deposit decay rates, and the market
values of certain assets under differing interest rate scenarios, among others.
As with any method of measuring interest rate risk, certain
shortcomings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable rate mortgage loans,
have features that restrict changes in interest rates on a short-term basis and
over the life of the asset. Further, if interest rates change, expected rates of
prepayments on loans and early withdrawals from certificates could deviate
significantly from those assumed in calculating the table.
18
PART II--OTHER INFORMATION FOR
SECURITY FINANCIAL BANCORP, INC.
Item 1. LEGAL PROCEEDINGS.
On August 22, 2001, PL Capital LLC and certain persons affiliated
with it (including two of Security Financial's present directors)
filed a lawsuit in the Court of Chancery of the State of Delaware
against Security Financial and its remaining directors styled PL
CAPITAL LLC ET AL. V. BONAVENTURA, ET AL., Civil Action No. 19068. A
description of this action and the Court's ruling are found in the
Company's Current Reports on Form 8-K filed with the Securities and
Exchange Commission and referred to below in Part II, Item 6 of this
Quarterly Report on Form 10-Q. Following the Court's ruling, the
Plaintiffs sought reimbursement of their legal fees from the
Defendants. The Defendants and the Plaintiffs have agreed in
principle to settle this matter for an amount of $285,000.
Item 2. CHANGES IN SECURITIES.
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. OTHER INFORMATION.
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
3.1 Certificate of Incorporation of Security Financial
Bancorp, Inc. (1)
3.2 Amended Bylaws of Security Financial Bancorp, Inc. (6)
4.0 Form of Stock Certificates of Security Financial
Bancorp, Inc. (1)
19
10.1 ESOP Loan Documents (2)
10.2 Employment Agreement between Security Federal Bank &
Trust and John P. Hyland (2)
10.3 Employment Agreement between Security Financial
Bancorp, Inc. and John P. Hyland (2)
10.4 Security Federal Bank & Trust Employee Severance
Compensation Plan (2)
10.5 Security Financial Bancorp, Inc. Supplemental Executive
Retirement Plan (3)
10.6 Security Financial Bancorp, Inc. 2000 Stock-Based
Incentive Plan (4)
10.7 Employment Agreement between Security Financial
Bancorp, Inc. and Security Federal Bank & Trust and
Patrick J. Hunt (5)
-------------------------------------------------
(1) Incorporated herein by reference from the exhibits to
Form SB-2, Registration Statement and amendments
thereto, initially filed on September 20, 1999,
Registration No. 333-87397.
(2) Incorporated herein by reference from the exhibits to
the Form 10-Q for the quarter ended March 31, 2000,
filed May 12, 2000.
(3) Incorporated herein by reference from the exhibits to
the Form 10-KSB for the year ended June 30, 2001,
filed September 28, 2000.
(4) Incorporated herein by reference from the Company's
Definitive Proxy Statement for the 2000 Annual Meeting
of Stockholders, filed September 19, 2000.
(5) Incorporated herein by reference from the exhibits to
the Form 10-Q for the quarter ended March 31, 2001,
filed May 15, 2001.
(6) Incorporated herein by reference from the exhibits to
the Form 10-KSB for the year ended June 30, 2001,
filed September 28, 2001.
20
(b) Reports on Form 8-K
On October 2, 2001, the Company filed a Current
Report on Form 8-K attaching as an exhibit a press release
reporting the final disposition of legal action initiated
against the Company in August 2001. Specifically, the press
release reported that the Court of Chancery of the State of
Delaware in the case of PL CAPITAL LLC ET AL. V. BONAVENTURA,
ET AL. had ruled that as a matter of law, the risk of
nonpublication was borne by the Company, and because a July 13
Company press release was not in fact published, the Company
cannot enforce its advance notice bylaw against Mr. Cainkar, a
Company shareholder, who filed an intent to nominate directors
with the Company less than 90 days prior to the Company's
upcoming annual meeting.
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SECURITY FINANCIAL BANCORP, INC.
Date: February 14, 2002 By: /s/ John P. Hyland
-------------------
John P. Hyland
President and Chief Executive
Officer
Date: February 14, 2002 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
21