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 March 31, 2002
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 small business issuer 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 May 1, 2002, Security
Financial had 1,865,256 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 March 31, 2002
and June 30, 2001 3
Consolidated Statements of Income for the Three and Nine
Months Ended March 31, 2002 and 2001 4 and 5
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended March 31, 2002 6
Consolidated Statements of Cash Flows for the Nine Months
Ended March 31, 2002 and 2001 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 and Use of Proceeds 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
March 31, 2002 and June 30, 2001
(Unaudited)
(Dollars in thousands)
March 31, June 30,
2002 2001
---- ----
Assets:
Cash and due from financial institutions $ 5,419 $ 4,938
Interest-bearing deposits in financial institutions 35,630 21,563
---------- ----------
Cash and cash equivalents 41,049 26,501
Securities available for sale 37,002 46,197
Loans held for sale 934 1,139
Loans receivable, net of allowance for loan losses of $1,522 at
March 31, 2002 and $1,486 at June 30, 2001 102,428 111,147
Federal Home Loan Bank stock 5,300 5,300
Cash surrender value of life insurance policies 6,412 6,164
Other real estate owned 179 197
Premises and equipment, net 5,102 5,414
Accrued interest receivable and other assets 1,766 2,858
---------- ----------
Total assets $ 200,172 $ 204,917
========== ==========
Liabilities and Stockholders' Equity:
Liabilities:
Demand, NOW and money market deposits $ 21,249 $ 20,568
Savings 45,912 38,951
Time deposits 80,929 89,981
---------- ----------
Total deposits 148,090 149,500
Federal Home Loan Bank advances 15,000 15,000
Other borrowed funds 25 100
Advances from borrowers for taxes and insurance 423 428
Accrued interest and other liabilities 391 1,819
---------- ----------
Total liabilities 163,929 166,847
Stockholders' Equity:
Common stock 194 194
Additional paid-in capital 18,409 18,461
Unearned ESOP (1,318) (1,396)
Unearned stock awards (1,013) -
Treasury stock (1,444) -
Retained earnings, substantially restricted 21,591 20,940
Accumulated other comprehensive loss (176) (129)
---------- ----------
Total stockholders' equity 36,243 38,070
---------- ----------
Total liabilities and stockholders' equity $ 200,172 $ 204,917
========== ==========
See accompanying notes to consolidated financial statements.
3
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Three Months Ended March 31, 2002 and 2001
(Unaudited)
(In thousands, except per share data)
2002 2001
---- ----
Interest and dividend income:
Loans, including fees $ 2,003 $ 2,544
Securities 685 1,016
Other interest-earning assets 118 100
--------- ---------
Total interest income 2,806 3,660
Interest expense:
Deposits 990 1,637
Federal Home Loan Bank advances 190 -
Other borrowed funds - 175
--------- ---------
Total interest expense 1,180 1,812
--------- ---------
Net interest income 1,626 1,848
Provision for loan losses 45 45
--------- ---------
Net interest income after provision for loan losses 1,581 1,803
Noninterest income:
Service charges and other fees 66 59
Loan charges and servicing fees 53 53
Gain on sale of loans from secondary market activities 59 29
Gain on sale of other real estate owned 2 5
Increase in cash surrender value of life insurance 75 79
Other 112 93
--------- ---------
Total noninterest income 367 318
Noninterest expense:
Compensation and benefits 824 771
Occupancy and equipment 264 339
Advertising and promotions 37 35
Data processing 24 106
Legal fees 32 45
Other 285 291
--------- ---------
Total noninterest expense 1,466 1,587
--------- ---------
Income before income taxes 482 534
Income taxes 165 187
--------- ---------
Net income $ 317 $ 347
========= =========
Earnings per share - basic and diluted $ .19 $ .19
Comprehensive income $ 172 $ 503
See accompanying notes to consolidated financial statements.
4
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Nine Months Ended March 31, 2002 and 2001
(Unaudited)
(In thousands)
2002 2001
---- ----
Interest and dividend income:
Loans, including fees $ 6,338 $ 7,906
Securities 2,383 2,494
Other interest-earning assets 497 406
--------- ---------
Total interest income 9,218 10,806
Interest expense:
Deposits 3,629 4,879
Federal Home Loan Bank advance 576 177
Borrowed funds 2 -
--------- ---------
Total interest expense 4,207 5,056
--------- ---------
Net interest income 5,011 5,750
Provision for loan losses 135 135
--------- ---------
Net interest income after provision for loan losses 4,876 5,615
Noninterest income:
Service charges and other fees 227 179
Loan charges and servicing fees 168 172
Gain on sale of loans from secondary market activities 159 61
Gain on sale of other real estate owned 42 17
Increase in cash surrender value of life insurance 248 79
Other 352 289
--------- ---------
Total noninterest income 1,196 797
Noninterest expense:
Compensation and benefits 2,470 2,522
Occupancy and equipment 868 1,074
Advertising and promotions 94 150
Data processing 179 314
Legal fees 662 133
Other 882 940
--------- ---------
Total noninterest expense 5,155 5,133
--------- ---------
Income before income taxes 917 1,279
Income taxes 266 292
--------- ---------
Net income $ 651 $ 987
========= =========
Earnings per share - basic $ .38 $ .55
Earnings per share - diluted $ .37 $ .55
Comprehensive income $ 604 $ 1,307
See accompanying notes to consolidated financial statements.
5
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statement of Changes in Stockholders' Equity
For the Nine Months Ended March 31, 2002
(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 - 73 78 - - - - 151
Stock awards issued
- 72,834 shares - (125) - (1,187) - - 1,312 -
Stock awards earned - - - 174 - - - 174
Purchase 143,038 shares
of treasury stock - - - - - - (2,756) (2,756)
Comprehensive income:
Net income - - - - 651 - - 651
Change in unrealized loss
on securities available-
for-sale - - - - - (47) - (47)
---------
Total comprehensive
income 604
------- ---------- --------- -------- --------- --------- -------- ---------
Balance at March 31,
2002 $ 194 $ 18,409 $ (1,318) $ (1,013) $ 21,591 $ (176) $ (1,444) $ 36,243
======= ========== ========= ======== ========= ========= ======== =========
See accompanying notes to consolidated financial statements.
6
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Cash Flows
For Nine Months Ended March 31, 2002 and 2001
(Unaudited)
(In thousands)
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 651 $ 987
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation 358 474
Provision for loan losses 135 135
Gain on other real estate owned (42) 23
Origination and purchase of loans held for sale (11,748) (6,453)
Proceeds from sales of loans held for sale 12,112 6,009
Gain on sale of loans for secondary market (159) (61)
ESOP expense 151 125
Stock award expense 174 -
Accretion of discount on securities (169) (313)
Increase in cash surrender value of life insurance (248) (79)
Change in other assets 1,123 46
Change in other liabilities (1,428) (445)
---------- ----------
Net cash from operating activities 910 448
Cash flows from investing activities:
Proceeds from maturities and calls of securities available for sale 41,321 31,211
Principal payments on securities available for sale 1,334 917
Purchase of securities available for sale (33,369) (55,944)
Proceeds from maturities of time deposits with other financial institutions - 4,000
Change in loans 8,523 11,953
Investment in life insurance policies - (6,000)
Purchase of premises and equipment (46) (493)
Proceeds from sale of other real estate 121 364
---------- ----------
Net cash from investing activities 17,884 (13,992)
Cash flows from financing activities:
Change in deposits (1,410) 2,021
Change in advance payments by borrowers for taxes and insurance (5) 148
Proceeds from other borrowed funds - 125
Repayments of other borrowed funds (75) -
Proceeds from advances from Federal Home Loan Bank - 15,000
Purchase of treasury stock (2,756) -
---------- ----------
Net cash from financing activities (4,246) 17,294
---------- ----------
Net increase in cash and cash equivalents 14,548 3,750
Cash and cash equivalents at beginning of period 26,501 9,854
---------- ----------
Cash and cash equivalents at end of period $ 41,049 $ 13,604
========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 4,247 $ 4,988
Taxes 420 506
Transfer from loans to foreclosed real estate 61 176
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 accounting principles generally
accepted in the United States of America for complete financial statements. In
the opinion of management, all of the adjustments (consisting of a normal
recurring nature) considered necessary for a fair presentation have been
included. Operating results for the three and nine months ended March 31, 2002
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 Form 10-KSB
for the year ended June 30, 2001.
(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 March 31,
2002 and 2001:
2002 2001
---- ----
Basic
Net income $ 317 $ 347
========== =========
Weighted average common shares outstanding 1,674 1,795
========== =========
Basic earnings per common share $ .19 $ .19
========== =========
8
2002 2001
---- ----
Diluted
Net income $ 317 $ 347
=========== ==========
Weighted average common shares outstanding 1,674 1,795
Diluted effect of stock options and stock awards 28 -
----------- ----------
Diluted average common shares 1,702 1,795
=========== ==========
Diluted earnings per share $ .19 $ .19
=========== ==========
The following table presents a reconciliation of the components used to
compute basic and diluted earnings per share for the nine months ended March 31,
2002 and 2001:
2002 2001
---- ----
Basic
Net income $ 651 $ 987
=========== ==========
Weighted average common shares outstanding 1,721 1,793
=========== ==========
Basic earnings per common share $ .38 $ .55
=========== ==========
Diluted
Net income $ 651 $ 987
=========== ==========
Weighted average common shares outstanding 1,721 1,793
Diluted effect of stock options and stock awards 23 -
----------- ----------
Diluted average common shares 1,744 1,793
=========== ==========
Diluted earnings per share $ .37 $ .55
=========== ==========
At March 31, 2002, options to purchase 17,445 shares and 3,000 unearned
stock awards were not included in the year-to-date 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 nine months ended March 31, 2002 and were therefore antidilutive.
(4) Comprehensive Income
Nine Months Ended
March 31, March 31,
2002 2001
---- ----
Net income $ 651 $ 987
Comprehensive income - net of taxes
Unrealized gain (loss) on securities available-for-sale (47) 320
----------- ----------
Comprehensive income $ 604 $ 1,307
=========== ==========
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 holding
companies for thrift institutions, is subject to interest rate risk to the
degree
10
that its interest-bearing 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 nine months ended March 31, 2002
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 MARCH 31, 2002 AND JUNE 30, 2001
Total assets decreased by $4.7 million to $200.2 million at March 31, 2002
from $204.9 million at June 30, 2001.
Total loans declined to $102.4 million at March 31, 2002 from $111.1
million at June 30, 2001, or 7.8%. Residential mortgage loan balances declined
by $12.0 million as loans paid down or were refinanced. These balances were not
replaced by new originations because the Bank sells the majority of the
fixed-rate, long-term mortgages that it originated. Consumer loans declined by
$5.3 million as loans from the Bank's discontinued indirect lending program were
paid down. These decreases were partially offset by an increase of $8.8 million
in commercial loan balances.
The allowance for loan losses increased by $36,000 to $1.5 million at
March 31, 2002 based upon management's assessment of probable losses in the
portfolio. In order to establish the allowance, management evaluates larger
commercial, commercial real estate, and construction loans individually for
impairment based upon collateral sales and other factors.
Total deposits decreased to $148.1 million at March 31, 2002, from $149.5
million at June 30, 2001, a decline of .9%. Time deposits decreased by $9.1
million, savings accounts increased by $7.0 million, and other deposits
increased by $681,000.
Total stockholders' equity at March 31, 2002 was $36.2 million compared to
$38.1 million at June 30, 2001, a decrease of $1.9 million. The decrease was
primarily attributable to the Company's purchase of 143,038 of its outstanding
shares through its repurchase program, 72,834 of which were purchased by the
Company's Stock-Based Incentive Plan. A $47,000 additional unrealized loss on
securities available for sale, net of taxes, also decreased total equity. These
decreases in equity were partially offset by year-to-date net income of
$651,000, the reduction of unearned ESOP shares of $151,000, and the reduction
of unearned Incentive Plan shares of $174,000.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND
2001
GENERAL. Net income for the three-month period ended March 31, 2002 was
$317,000 compared to net income of $347,000 for the comparable period in 2001, a
decrease of $30,000. The decrease was primarily attributable to a decrease in
net interest income of $222,000. This decrease was partially offset by an
increase in non-interest income of $49,000, a decrease in non-interest expense
of $121,000, and a decrease in income tax expense of $22,000.
11
INTEREST INCOME. Interest income for the quarter ended March 31, 2002 was
$2.8 million compared to $3.7 million for the quarter ended March 31, 2001, a
decrease of $854,000, or 23.3%. The decrease was primarily attributable to a
significant decrease in the yield earned on our interest-earning assets, which
decreased to 6.18% for the three-month period ended March 31, 2002 from 7.91%
for the same period in 2001. The average balance of interest-earning assets
decreased to $181.7 million for the three months ended March 31, 2002 from
$185.1 million for the same period in 2001. The yield earned on the Company's
cash balances has dropped by approximately 315 basis points for the comparable
periods.
INTEREST EXPENSE. Interest expense for the quarter ended March 31, 2002
was $1.2 million compared to $1.8 million for the quarter ended March 31, 2001,
a decrease of $632,000, or 34.9%. 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 2.60%
for the three-month period ended March 31, 2002 from 3.92% for the same period
in 2001. Our cost of funds decreased to 3.01% for the three months ended March
31, 2002 from 4.44% for the three months ended March 31, 2001, reflecting a
general decrease in interest rates in the quarter ended March 31, 2002. A
decrease in the average balance of interest-bearing liabilities to $157.0
million for the quarter ended March 31, 2002 from $163.5 million during the
quarter ended March 31, 2001 also contributed to the decrease in interest
expense.
NET INTEREST INCOME. Net interest income decreased to $1.6 million for the
three-month period ended March 31, 2002 from $1.8 million, a decrease of
$222,000, or 12.3%. The net interest margin decreased to 3.58% from 3.99% 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
reflect 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 borrower's
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 for the three
months ended March 31, 2002 and 2001. We used the same methodology and generally
similar assumptions in assessing the adequacy of the allowance for both periods.
The allowance for loan losses was $1.5 million, or 1.47%, of loans outstanding
at March 31, 2002, as compared with $1.5 million, or 1.32%, of loans outstanding
at June 30, 2001. The allowance for loan losses to non-performing loans was
75.3% at March 31, 2002, as compared to 102.7% 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
12
their examination process, periodically review the allowance for 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 March 31, 2002 was maintained at a level that represents
management's best estimate of probable incurred losses in the loan portfolio.
NONINTEREST INCOME. Noninterest income was $367,000 for the three months
ended March 31, 2002 compared to $318,000 for the three-month period ended March
31, 2001, an increase of $49,000, or 15.4%. The increase was primarily
attributable to an increase of $30,000 from gains on the sale of loans from
secondary market activities, a $7,000 increase in deposit service charges and
approximately $11,000 of additional miscellaneous income.
NONINTEREST EXPENSE. Noninterest expense for the quarter ended March 31,
2002 was $1.5 million compared to $1.6 million for the quarter ended March 31,
2001, a decrease of $121,000, or 7.6%. An increase in compensation and benefits
expense of $53,000 was offset by continued decreases in occupancy and equipment
expense totaling $75,000, an $82,000 decrease in data processing expense, and a
$13,000 decrease in legal expense.
INCOME TAXES. Tax net operating loss carryforwards 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
$165,000 for the three months ended March 31, 2002. This compares to $187,000 of
income tax expense for the quarter ended March 31, 2001.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED MARCH 31, 2002 AND
2001
GENERAL. Net income for the nine-month period ended March 31, 2002 was
$651,000 compared to net income of $987,000 for the comparable period in 2001, a
decrease of $336,000. 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 nine months ended March 31, 2002
was $9.2 million compared to $10.8 million for the nine months ended March 31,
2001, a decrease of $1.6 million, or 14.7%. The decrease was primarily
attributable to a significant decrease in the yield earned on our
interest-earning assets, which decreased to 6.67% for the nine-month period
ended March 31, 2002 from 7.98% for the same period in 2001. The decrease in
interest income due to changes in interest rates was offset slightly by an
increase in the average balance of interest-earning assets to $184.4 million for
the nine months ended March 31, 2002 from $180.6 million for the same period in
2001. The yield earned on the Company's cash balances has decreased by
approximately 315 basis points for the comparable periods.
INTEREST EXPENSE. Interest expense for the nine months ended March 31,
2002 was $4.2 million compared to $5.1 million for the nine months ended March
31, 2001, a decrease of $849,000, or 16.8%. 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 3.05% for the nine-month period ended March 31, 2002 from 3.74% for
the same period in 2001. Our cost of funds decreased to 3.49% for the nine
months ended March 31, 2002 from 4.36% for the nine months ended March 31, 2001,
reflecting a general decrease in
13
interest rates in the nine-month period ended March 31, 2002. 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 $160.5 million for the
nine months ended March 31, 2002 from $154.5 million for the nine months ended
March 31, 2001. 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 $5.0 million for the
nine-month period ended March 31, 2002 from $5.8 million, a decrease of
$739,000, or 12.9%. The net interest margin decreased to 3.62% from 4.24% 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 $135,000 for the nine months ended March
31, 2002 and 2001. We used the same methodology and generally similar
assumptions in assessing the adequacy of the allowance for both periods. The
provision for the nine months ended March 31, 2002 reflects an increase in loans
classified as substandard from $2.1 million at June 30, 2001 to $2.4 million at
March 31, 2002 and $99,000 in net charge-offs during the nine months ended March
31, 2002.
NONINTEREST INCOME. Noninterest income was $1.2 million for the nine
months ended March 31, 2002 compared to $797,000 for the nine months ended March
31, 2001, an increase of $399,000, or 50.1%. The increase is primarily
attributable to $169,000 of additional income on bank-owned life insurance that
was purchased during the second and third quarters of fiscal 2001, an increase
in gains on the sale of mortgage loans from secondary market activities of
$98,000, an increase in deposit service charges of $48,000, an increase in gains
on the sale of other real estate owned of $25,000, and approximately $63,000 of
additional miscellaneous income.
NONINTEREST EXPENSE. Noninterest expense for the nine months ended March
31, 2002 was $5.2 million compared to $5.1 million for the nine months ended
March 31, 2001, an increase of $22,000, or .4%. The increase for the nine-month
period was due to an increase in legal fees of $529,000, a majority of which
relates to one-time costs associated with a stockholder lawsuit. In April 2002,
the Company was reimbursed $142,500 of this amount by its insurance carrier.
This will be recognized in the fourth quarter of fiscal 2002. Most of the
increase in legal fees was offset by continued cost-cutting measures by
management.
INCOME TAXES. Tax net operating loss carryforwards were fully utilized
during the quarter ended December 31, 2000, causing the Company to begin
recognizing income tax expense. The
14
Company recorded income tax expense of $266,000 for the nine months ended March
31, 2002. This compares to $292,000 of income tax expense for the nine months
ended March 31, 2001. The decline was the result of lower pretax earnings in
2002.
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. In addition, the Office of Thrift Supervision (OTS)
regulations require the Bank to maintain sufficient liquidity to maintain the
Bank's safe and sound operation.
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 $170,000 and
$448,000 for the nine months ended March 31, 2002 and 2001. 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 March 31, 2002, cash and
cash equivalents totaled $41.0 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 March 31, 2002, the Company had the
ability to borrow a total of approximately $27.0 million from the Federal Home
Loan Bank of Indianapolis. On that date, the Company had $15.0 million of
outstanding advances.
At March 31, 2002, the Company had outstanding commitments to originate
loans of $4.1 million. Of this total, $1.6 million had fixed rates and $2.5
million had floating rates. 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 March 31, 2002
totaled $70.0 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 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
15
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 March 31, 2002:
Total capital
(to risk-
weighted
assets) $ 30,584 27.0% $ 9,077 8.0% $ 11,346 10.0%
Tier 1 capital
(to risk-
weighted
assets) 29,226 25.8 4,538 4.0 6,807 6.0
Core capital
(to adjusted
assets) 29,226 14.7 7,937 4.0 9,921 5.0
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.
16
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
----------------------------------------------------------
In an attempt to manage its exposure to changes in interest rates,
management monitors the Company's interest rate risk. The Board of Directors
reviews at least quarterly the Company's interest rate risk position and
profitability. The Board of Directors also reviews Company's portfolio,
formulates investment strategies, and oversees the timing and implementation of
transactions to ensure attainment of Company's objectives in the most effective
manner. In addition, the Board reviews on a quarterly basis Company's
asset/liability position, including simulations of the effect on Company's
capital of various interest rate scenarios.
In managing its asset/liability mix, the Company, 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 the Company's
vulnerability to changes in interest rates. First, Security Federal uses
customer service and marketing efforts to increase Security Federal's
noncertificate accounts. At March 31, 2002, $67.2 million, or 45.4%, 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 interest rates.
Finally, Security Federal has focused a significant portion of its investment
activities on securities with terms of five years or less. At March 31, 2002,
$3.2 million, or 9%, of Security Federal's securities had terms to maturity of
five years or less based on their carrying value in addition to Security
Federal's mortgage-backed securities, which provide for regular principal
repayments.
The Office of Thrift Supervision provides the Security Federal with the
information presented in the following table. It presents the change in the
Security Federal's net portfolio value at March 31, 2002 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.
17
NPV as % of
Change in Portfolio Value of Assets
Interest Rates Net Portfolio Value -------------------------
in Basis Points ------------------- NPV Basis Point
(Rate Shock) Amount $ Change % Change Ratio Change
------------ ------ -------- -------- ----- ------
(Dollars in thousands)
300 $ 27,770 (8,734) (23.9)% 14.43% -351 bp
200 30,484 (6,020) (16.5) 15.57 -238 bp
100 33,222 (3,282) (9.0) 16.67 -128 bp
Static 36,504 - 17.94 -
(100) 36,753 249 .7 17.96 2 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 settled this
matter for the amount of $285,000. The Company was reimbursed
$142,500 of this amount by its insurance carrier in the fourth
quarter of fiscal year 2002.
Item 2. Changes in Securities and Use of Proceeds.
-----------------------------------------
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)
10.1 ESOP Loan Documents (2)
19
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.
(b) Reports on Form 8-K.
None.
20
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: May 15, 2002 By: /s/ John P. Hyland
------------------
John P. Hyland
President and Chief Executive
Officer
Date: May 15, 2002 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
21