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, 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 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
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, 2003,
Security Financial had 1,863,951 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, 2002
and June 30, 2002 3
Consolidated Statements of Income for the Three and Six
Months Ended December 31, 2002 and 2001 4 and 5
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended December 31, 2002 6
Consolidated Statements of Cash Flows for the Six Months
Ended December 31, 2002 and 2001 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 19
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 23
CERTIFICATIONS 24
2
PART I--FINANCIAL INFORMATION FOR
SECURITY FINANCIAL BANCORP, INC.
Item 1. FINANCIAL STATEMENTS.
SECURITY FINANCIAL BANCORP, INC.
Consolidated Balance Sheets
December 31, 2002 and June 30, 2002
(Dollars in thousands)
(Unaudited)
December 31, June 30,
2002 2002
---- ----
Assets:
Cash and due from financial institutions $ 6,113 $ 5,729
Interest-bearing deposits in financial institutions 36,779 36,515
----------- -----------
Cash and cash equivalents 42,892 42,244
Securities available for sale 36,819 33,980
Loans held for sale 2,842 1,468
Loans receivable, net of allowance for loan losses of $1,438 at
December 31, 2002 and $1,479 at June 30, 2002 97,610 105,489
Federal Home Loan Bank stock 5,300 5,300
Cash surrender value of life insurance 6,646 6,489
Other real estate owned 615 129
Premises and equipment, net 4,522 4,681
Accrued interest receivable 1,110 930
Other assets 400 482
----------- -----------
Total assets $ 198,756 $ 201,192
=========== ===========
Liabilities and Stockholders' Equity:
Liabilities:
Demand, NOW and money market deposits $ 21,219 $ 21,615
Savings 46,898 45,650
Time deposits 77,409 81,028
----------- -----------
Total deposits 145,526 148,293
Federal Home Loan Bank advances 15,000 15,000
Advances from borrowers for taxes and insurance 190 197
Accrued interest payable and other liabilities 1,003 760
----------- -----------
Total liabilities 161,719 164,250
Stockholders' Equity:
Common stock 19 19
Additional paid-in capital 18,667 18,610
Unearned ESOP (1,241) (1,293)
Unearned stock awards (827) (955)
Retained earnings, substantially restricted 21,667 21,891
Accumulated other comprehensive loss 221 129
Treasury stock (1,469) (1,459)
----------- -----------
Total stockholders' equity 37,037 36,942
----------- -----------
Total liabilities and stockholders' equity $ 198,756 $ 201,192
=========== ===========
See accompanying notes to consolidated financial statements.
3
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Three Months Ended December 31, 2002 and 2001
(Unaudited)
(In thousands, except per share data)
2002 2001
---- ----
Interest and dividend income:
Loans, including fees $ 1,714 $ 2,123
Securities 462 775
Other interest-earning assets 131 150
----------- -----------
Total interest income 2,307 3,048
Interest expense:
Deposits 786 1,215
Federal Home Loan Bank advances 194 193
Other borrowed funds - 1
----------- -----------
Total interest expense 980 1,409
----------- -----------
Net interest income 1,327 1,639
Provision for loan losses - 45
----------- -----------
Net interest income after provision for loan losses 1,327 1,594
Noninterest income:
Service charges and other fees 88 85
Loan charges and servicing fees 66 60
Gain on sale of loans from secondary market activities 142 69
Gain on sale of other real estate owned 6 10
Increase in cash surrender value of life insurance 79 88
Insurance commission income 49 72
Other 72 48
----------- -----------
Total noninterest income 502 432
Noninterest expense:
Compensation and benefits 1,660 826
Occupancy and equipment 252 295
Advertising and promotions 33 24
Data processing 64 64
Legal fees 149 394
Other 289 297
----------- -----------
Total noninterest expense 2,447 1,900
----------- -----------
Income (loss) before income taxes (618) 126
Income tax expense (benefit) (269) 30
----------- -----------
Net income (loss) $ (349) $ 96
============ ===========
Earnings (loss) per share - basic $ (.21) $ .06
Earnings (loss) per share - diluted $ (.21) $ .06
Comprehensive income (loss) $ (204) $ (194)
See accompanying notes to consolidated financial statements.
4
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Six Months Ended December 31, 2002 and 2001
(Unaudited)
(In thousands, except per share data)
2002 2001
---- ----
Interest and dividend income:
Loans, including fees $ 3,525 $ 4,335
Securities 947 1,698
Other interest-earning assets 283 379
----------- -----------
Total interest income 4,755 6,412
Interest expense:
Deposits 1,656 2,639
Federal Home Loan Bank advance 388 386
Other borrowed funds - 2
----------- -----------
Total interest expense 2,044 3,027
----------- -----------
Net interest income 2,711 3,385
Provision for loan losses 10 90
----------- -----------
Net interest income after provision for loan losses 2,701 3,295
Noninterest income:
Service charges and other fees 181 161
Loan charges and servicing fees 117 115
Gain on sale of loans from secondary market activities 213 100
Gain on sale of other real estate owned 6 40
Increase in cash surrender value of life insurance 157 173
Insurance commission income 94 121
Other 133 119
----------- -----------
Total noninterest income 901 829
Noninterest expense:
Compensation and benefits 2,456 1,646
Occupancy and equipment 497 604
Advertising and promotions 61 57
Data processing 110 155
Legal fees 350 630
Other 582 597
----------- -----------
Total noninterest expense 4,056 3,689
----------- -----------
Income (loss) before income taxes (454) 435
Income tax expense (benefit) (230) 101
------------ -----------
Net income (loss) $ (224) $ 334
============ ===========
Earnings (loss) per share - basic $ (.13) $ .19
Earnings (loss) per share - diluted $ (.13) $ .19
Comprehensive income (loss) $ (132) $ 431
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, 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, 2002 $ 19 $ 18,610 $ (1,293) $ (955) $ 21,891 $ 129 $ (1,459) $ 36,942
ESOP shares earned - 57 52 - - - - 109
Stock awards earned - - - 118 - - - 118
Forfeited stock awards - - - 10 - - (10) -
Comprehensive income (loss):
Net income (loss) - - - - (224) - - (224)
Change in unrealized gain
on securities available-
for-sale - - - - - 92 - 92
Total comprehensive
income (loss) (132)
--------- --------- --------- --------- --------- --------- -------- ---------
Balance at December 31, 2002 $ 19 $ 18,667 $ (1,241) $ (827) $ 21,667 $ 221 $ (1,469) $ 37,037
========= ========= ========= ========= ========= ========= ======== =========
See accompanying notes to consolidated financial statements.
6
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Cash Flows
For the Six Months Ended December 31, 2002 and 2001
(Unaudited)
(In thousands)
2002 2001
---- ----
Cash flows from operating activities:
Net income (loss) $ (224) $ 334
Adjustments to reconcile net income (loss) to net cash from
operating activities:
Depreciation 177 269
Provision for loan losses 10 90
(Gain) loss on other real estate owned (6) (40)
Origination and purchase of loans held for sale (19,822) (8,169)
Proceeds from sales of loans held for sale 18,661 8,059
Gain on sale of loans from secondary market activities (213) (100)
ESOP expense 109 99
Stock award expense 118 114
Amortization (accretion) of premium/discount on securities 262 (160)
Increase in cash surrender value of life insurance (157) (173)
Change in accrued interest receivable and other assets (160) 836
Change in accrued interest payable and other liabilities 243 (1,120)
----------- -----------
Net cash from operating activities (1,002) 39
Cash flows from investing activities:
Proceeds from maturities and calls of securities available for sale 25,644 24,202
Principal payments on securities available for sale 146 1,140
Purchase of securities available for sale (28,737) (20,512)
Change in loans 7,211 1,499
Change in premises and equipment, net (18) (41)
Proceeds from sale of other real estate 178 142
----------- -----------
Net cash from investing activities 4,424 6,430
Cash flows from financing activities:
Change in deposits (2,767) (3,547)
Change in advance payments by borrowers for taxes and insurance (7) (191)
Repayments of other borrowed funds - (50)
Purchase of treasury stock - (1,657)
----------- -----------
Net cash for financing activities (2,774) (5,445)
----------- -----------
Net increase in cash and cash equivalents 648 1,024
Cash and cash equivalents at beginning of period 42,244 26,501
----------- -----------
Cash and cash equivalents at end of period $ 42,892 $ 27,525
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 2,044 $ 3,057
Taxes 220 400
Transfer from loans to foreclosed real estate 658 61
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, 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 June 30, 2002
Form 10-K.
(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,
2002 and 2001:
2002 2001
---- ----
Basic
Net income (loss) $ (349) $ 96
============ ===========
Weighted average common shares outstanding 1,689 1,721
=========== ===========
Basic earnings (loss) per common share $ (.21) $ .06
============ ===========
8
2002 2001
---- ----
Diluted
Net income (loss) $ (349) $ 96
============ ===========
Weighted average common shares outstanding 1,689 1,721
Diluted effect of stock options and stock awards - 24
----------- -----------
Diluted average common shares 1,689 1,745
=========== ===========
Diluted earnings (loss) per share $ (.21) $ .06
============ ===========
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, 2002 and 2001:
2002 2001
---- ----
Basic
Net income (loss) $ (224) $ 334
============ ===========
Weighted average common shares outstanding 1,686 1,744
=========== ===========
Basic earnings (loss) per common share $ (.13) $ .19
============ ===========
Diluted
Net income (loss) $ (224) $ 334
============ ===========
Weighted average common shares outstanding 1,686 1,744
Diluted effect of stock options and stock awards 33 20
----------- -----------
Diluted average common shares 1,719 1,764
=========== ===========
Diluted earnings (loss) per share $ (.13) $ .19
============ ===========
Basic and dilutive loss per share were the same for the three and six
months ended December 31, 2002 as diluted loss per share would be anti-dilutive.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 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.
PENDING MERGER WITH STANDARD BANCSHARES, INC.
On February 6, 2003, Standard Bancshares, Inc. ("Standard") and the Company
entered into an Agreement and Plan of Reorganization (the "Agreement") pursuant
to which the Company will merge with and into Standard. Standard is the parent
company of Standard Bank and Trust Co., an Illinois-chartered bank. Under the
terms of the Agreement, the stockholders of the Company will receive $24.00 in
cash in exchange for each share of Company common stock. The transaction is
subject to several conditions, including the receipt of regulatory approvals and
the approval of the stockholders of the Company.
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 loans, 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. Security
Federal also offers insurance products through its wholly owned insurance
agency, The Boulevard, Inc., and trust services through its trust department.
The Company's revenues are derived principally from interest earned on loans and
securities, gains from sales
10
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 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,
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 December 31, 2002 and June 30, 2002.
Total assets decreased by $2.4 million to $198.8 million at December 31,
2002 from $201.2 million at June 30, 2002.
Net loans declined to $97.6 million at December 31, 2002 from $105.5
million at June 30, 2002, or 7.5%. Residential mortgage loan balances declined
by $7.6 million as loans paid down or refinanced. These balances are not
replaced by new originations because the Bank sells the majority of the fixed
rate long-term mortgages that it originates. Consumer loans declined by $1.5
million as loans from the Bank's discontinued indirect lending program continue
to pay down. Commercial loan balances increased by $1.2 million.
Total deposits decreased to $145.5 million at December 31, 2002, from
$148.3 million at June 30, 2002, a decrease of $2.8 million. The decrease was
caused by a $3.6 million decline in time deposits offset slightly by a $1.2
million increase in savings.
Total stockholders' equity at December 31, 2002 was $37.0 million compared
to $36.9 million at June 30, 2002. The increase resulted from a $118,000
increase related to Incentive Plan stock awards earned; a $109,000 increase
related to the release of ESOP shares; and a $92,000 increase in the fair value
of securities available for sale, net of taxes. These increases were offset by
the net loss of $224,000 for the six months ended December 31, 2002.
Comparison of Operating Results for the Three Months Ended December 31, 2002 and
2001
General. The net loss for the three-month period ended December 31, 2002
was $349,000 compared to net income of $96,000 for the comparable period in
2001, a decrease of $445,000.
11
The decrease is primarily attributable to a $805,000 ($486,000 net of tax)
payment to CEO John P. Hyland in exchange for his consent to the termination of
his employment agreements with the Company and the Bank. The board of directors
of the Company analyzed and discussed the potential future cost of termination
payments that could be made to Mr. Hyland (including tax gross-up payments)
under the contracts in connection with a change in control. The Board considered
that the potential severance payments under the agreements in the event of Mr.
Hyland's termination following a change in control would continue to grow
over time and determined that it was in the best interest of the Company to
terminate the employment agreements to limit any exposure to increasing
severance payments, and potentially high gross up payments. The Company
discussed this matter with Mr. Hyland and Mr. Hyland agreed that these payments
could limit the ability of the Company to pursue potential strategic alliances
and accordingly agreed to terminate his employment agreements with the Company
and the Bank in exchange for the cash settlement amount. Mr. Hyland will
continue in his position as President and Chief Executive Officer and director
of each of the Company and Bank. The decrease in net income was also
attributable to a $267,000 decrease in net interest income after provision for
loan losses. Part of the decrease was offset by a $73,000 increase in gains on
the sale of loans from secondary market activities, a $245,000 decrease in legal
fees, a $43,000 decrease in occupancy and equipment expense and a $299,000
decrease in income tax expense.
Interest Income. Interest income for the quarter ended December 31, 2002
was $2.3 million compared to $3.0 million for the quarter ended December 31,
2001, a decrease of $741,000, or 24.3%. The decrease was primarily attributable
to a significant decrease in the yield earned on our interest earning assets
which decreased to 5.08% for the three-month period ended December 31, 2002 from
6.72% for the same period in 2001. The yield earned on the Company's cash
balances decreased approximately 69 basis points for the compared periods.
Interest Expense. Interest expense for the quarter ended December 31, 2002
was $980,000 compared to $1.4 million for the quarter ended December 31, 2001, a
decrease of $429,000 or 30.4%. 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 2.16%
for the three-month period ended December 31, 2002 from 3.10% for the same
period in 2001. Our cost of funds decreased to 2.53% for the three months ended
December 31, 2002 from 3.53% for the three months ended December 31, 2001.
Net Interest Income. Net interest income decreased to $1.3 million for the
three-month period ended December 31, 2002 from $1.6 million, a decrease of
$312,000, or 19.0%. The net interest margin decreased to 2.92% from 3.62% during
the same periods. The decrease in the net interest margin is attributable
primarily to a significant decrease in market interest rates and a significant
increase in the Company's liquidity.
Provision for Loan Losses. The Company establishes 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, the Company evaluates
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
12
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 the Company's
evaluation of these factors, management made no provisions for the three months
ended December 31, 2002 and $45,000 of provisions for the three months ended
December 31, 2001. The Company used the same methodology and generally similar
assumptions in assessing the adequacy of the allowance for both periods. The
allowance for loan losses was $1.4 million, or 1.41% of loans outstanding at
December 31, 2002, as compared with $1.5 million, or 1.38% of loans outstanding
at June 30, 2002. The allowance for loan losses to non-performing loans was
113.9% at December 31, 2002, as compared to 60.1% at June 30, 2002. 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 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, 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 $502,000 for the three months
ended December 31, 2002 compared to $432,000 for the three-month period ended
December 31, 2001, an increase of $70,000, or 16.2%. The increase is primarily
attributable to $73,000 increase in gains on the sale of mortgage loans from
secondary market activities and an increase in loan charges and service fees of
$6,000. The increase was partially offset by a decrease of $8,000 from income
from bank owned life insurance.
Noninterest Expense. Noninterest expense for the quarter ended December 31,
2002 was $2.4 million compared to $1.9 million for the quarter ended December
31, 2001, an increase of $547,000, or 28.8%. The increase was primarily
attributable to a $805,000 payment to CEO John P. Hyland in exchange for has
consent to the termination of his employment agreements with the Company and the
Bank. This increase in compensation and benefits was partially offset by a
$245,000 decrease in legal fees, a $43,000 decrease in occupancy and equipment
expense. Legal fees for the 2001 period related to a one-time settlement of a
shareholder suit.
Income Taxes. The Company recorded an income tax benefit of $269,000 for
the quarter ended December 31, 2002 due to the Company's loss in the 2002
quarter. This compares to income tax expense of $30,000 for the quarter ended
December 31, 2001.
Comparison of Operating Results for the Six Months Ended December 31, 2002 and
2001
General. The net loss for the six-month period ended December 31, 2002 was
$224,000 compared to net income of $334,000 for the comparable period in 2001, a
decrease of $558,000. The decrease is primarily attributable to a $805,000
($486,000 net of tax) payment to CEO John P. Hyland in exchange for his consent
to the termination of his employment agreements with the Company and the Bank,
as previously discussed. The decrease was also attributable to a
13
$594,000 decrease in net interest income after provision for loan losses. Part
of the decrease was offset by a $113,000 increase in gains on the sale of loans
from secondary market activities, a $280,000 decrease in legal fees, a $107,000
decrease in occupancy and equipment expense, a $45,000 decrease in data
processing fees and a $331,000 decrease in income tax expense.
Interest Income. Interest income for the six months ended December 31, 2002
was $4.8 million compared to $6.4 million for the six months ended December 31,
2001, a decrease of $1.6 million, or 25.8%. The decrease was primarily
attributable to a significant decrease in the yield earned on our interest
earning assets which decreased to 5.26% for the six-month period ended December
31, 2002 from 7.0% for the same period in 2001. Both interest rates and the
average balance of interest earning assets declined during the compared periods.
The yield earned on the Company's cash balances decreased approximately 125
basis points for the compared periods.
Interest Expense. Interest expense for the six months ended December 31,
2002 was $2.0 million compared to $3.0 million for the six months ended December
31, 2001, a decrease of $983,000 or 32.5%. 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 2.26% for the six-month period ended December 31, 2002 from 3.30%
for the same period in 2001. Our cost of funds decreased to 2.61% for the six
months ended December 31, 2002 from 3.69% for the six months ended December 31,
2001, reflecting a general decrease in interest rates in the six-month period
ended December 31, 2002.
Net Interest Income. Net interest income decreased to $2.7 million for the
six-month period ended December 31, 2002 from $3.4 million, a decrease of
$674,000, or 19.9%. The net interest margin decreased to 3.0% from 3.69% during
the same periods. The decrease in the net interest margin is attributable
primarily to a significant decrease in market interest rates and a significant
increase in the Company's liquidity.
Provision for Loan Losses. The Company establishes 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, the Company evaluates
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 the
Company's evaluation of these factors, management made provisions of $10,000 and
$90,000 for the six months ended December 31, 2002 and 2001, respectively. The
Company used the same methodology and generally similar assumptions in assessing
the adequacy of the allowance for both periods. The allowance for loan losses
was $1.4 million, or 1.45% of loans outstanding at December 31, 2002, as
compared with $1.5 million, or 1.38% of loans outstanding at June 30, 2002. The
allowance for loan losses to non-performing loans was 113.9% at December 31,
2002, as compared to 60.1% at June 30, 2002. The level of the allowance is based
on estimates and the ultimate losses may vary from the estimates. Management
14
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 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, 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 $901,000 for the six months
ended December 31, 2002 compared to $829,000 for the six months ended December
31, 2001, an increase of $72,000, or 8.7%. The increase is primarily
attributable to an $113,000 increase in gains on the sale of mortgage loans from
secondary market activities, an increase in service charges and other fees of
$20,000, and a $14,000 increase in other noninterest income. These increases
were partially offset by a decrease of $16,000 from income on bank owned life
insurance, a decrease in gains on the sale of other real estate owned of $34,000
and a $27,000 decrease in insurance commission income.
15
Noninterest Expense. Noninterest expense for the six months ended December
31, 2002 was $4.1 million compared to $3.7 million for the six months ended
December 31, 2001, an increase of $367,000, or 9.9%. The increase was primarily
attributable to a $805,000 payment to CEO John P. Hyland in exchange for his
consent to the termination of his employment agreements with the Company and the
Bank. The increase was partially offset by a $280,000 decrease in legal fees, a
$107,000 decrease in occupancy and equipment expense and a $45,000 decrease in
data processing expense.
Income Taxes. The Company recorded an income tax benefit of $230,000 for
the six months ended December 31, 2002, due to the Company's loss in the 2002
period. This compares to income tax expense of $101,000 for the six months ended
December 31, 2001.
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 used in by operating activities were $1.0 million and
$39,000 for the six months ended December 31, 2002 and 2001, 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, 2002, cash and
cash equivalents totaled $42.9 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, 2002, the Company had
the ability to borrow a total of approximately $21 million from the Federal Home
Loan Bank of Indianapolis. On that date, the Company had $15 million of
outstanding advances.
At December 31, 2002, the Company had outstanding commitments to originate
loans of $6.7 million. Of this total, $6.1 million had fixed rates and $582,000
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, 2002 totaled $68.8 million. Management believes, based on past
experience, that a
16
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 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.
The Bank is subject to various regulatory capital requirements imposed by
the OTS at December 31, 2002, the Company was in compliance with all applicable
capital requirements.
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, 2002:
Total capital (to risk-
weighted assets) $ 31,508 27.4% $ 9,205 8.0% $ 11,506 10.0%
Tier 1 capital (to risk-
weighted assets) 30,280 26.3 4,602 4.0 6,904 6.0
Core capital (to adjusted
assets) 30,280 15.5 7,839 4.0 9,799 5.0
As of June 30, 2002:
Total capital (to risk-
weighted assets) $ 30,949 26.8% $ 9,246 8.0% $ 11,558 10.0%
Tier 1 capital (to risk-
weighted assets) 29,590 25.6 4,623 4.0 6,935 6.0
Core capital (to adjusted
assets) 29,590 14.9 7,940 4.0 9,925 5.0
17
IMPACT OF ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued SFAS No. 148,
ACCOUNTING FOR THE STOCK BASED COMPENSATION - TRANSITION AND DISCLOSURE, in
December 2002. SFAS No. 148 provides more choices on how to adopt SFAS No. 123,
ACCOUNTING FOR STOCK BASED COMPENSATION, and increases the disclosures if SFAS
No. 123 is not adopted. Adoption of this statement requires more prominent
disclosure of how an entity's accounting policy for stock-based compensation
affects net income. The Company is currently evaluating the requirements and
alternatives of adopting this statement.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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, 2002, $68.1 million, or 47%, 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 50.2% of Security Federal's loans carry adjustable
interest rates. Finally, Security Federal has focused a portion of its
investment activities on securities with terms of five years or less. At
December 31, 2002, $5.4 million, or 15%, 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.
18
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 December 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.
Change in NPV as % of
Interest Rates Net Portfolio Value Portfolio Value of Assets
in Basis Points ------------------- NPV Basis Point
(Rate Shock) Amount $ Change % Change Ratio Change
------------ ------ -------- -------- ----- ------
(Dollars in thousands)
300 $ 36,602 (283) (.8)% 18.09% 4bp
200 37,062 177 .5 18.23 18bp
100 37,170 285 .8 18.22 17bp
Static 36,885 - - 18.05
(100) 36,057 (828) (2.2) 17.66 (39)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. Based upon
the model at December 31, 2002, the effect of an immediate 300 basis point
increase or 100 basis point decrease would have a negative impact on the net
portfolio value. Due to the level of interest rates at December 31, 2002, the
OTS did not model an additional 200 or 300 basis point decrease in rates.
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.
Item 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. Based upon their evaluation of those
controls and procedures performed within 90 days of the filing date of this
19
report, the Chief Executive Officer and the Chief Financial Officer of the
Company concluded that the Company's disclosure controls and procedures were
adequate.
CHANGES IN INTERNAL CONTROLS
The Company made no significant changes in its internal controls or in
other factors that could significantly affect these controls subsequent to the
date of the evaluation of those controls by the Chief Executive Officer and
Chief Financial Officer.
20
PART II--OTHER INFORMATION FOR
SECURITY FINANCIAL BANCORP, INC.
Item 1. LEGAL PROCEEDINGS.
Security Financial is not a party to any pending legal proceedings.
Periodically, there have been various claims and lawsuits involving Security
Federal, such as claims to enforce liens, condemnation proceedings on properties
in which Security Federal holds security interests, claims involving the making
and servicing of real property loans, and other issues incident to Security
Federal's business. Security Federal is not a party to any pending legal
proceedings that it believes would have a material adverse effect on the
financial condition or operations of Security Federal.
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
2.1 Agreement and Plan of Reorganization, dated February 6,
2003, by and among Standard Bancshares, Inc., Standard
Acquisition Corporation and Security Financial Bancorp, Inc.
(7)
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)
10.2 Security Federal Bank & Trust Employee Severance
Compensation Plan (2)
21
10.3 Security Financial Bancorp, Inc. Supplemental Executive
Retirement Plan (3)
10.4 Security Financial Bancorp, Inc. 2001 Stock-Based Incentive
Plan (4)
10.5 Employment Agreement between Security Financial Bancorp,
Inc. and Security Federal Bank & Trust and Patrick J. Hunt
(5)
10.6 Tax Indemnification Agreement, by and among Security
Financial Bancorp, Inc. and John P. Hyland
-------------------------------------------------
(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.
(7) Incorporated herein by reference from the exhibits to the
Current Report on Form 8-K filed on February 13, 2003.
(b) Reports on Form 8-K
None.
22
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, 2003 By: /s/ John P. Hyland
------------------
John P. Hyland
President and Chief Executive
Officer
Date: February 14, 2003 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
23
CERTIFICATION
I, John P. Hyland, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Security
Financial Bancorp, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's Board of Directors (or persons
performing the equivalent function):
a. All significant deficiencies in the design or operation of
the internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 14, 2003 By: /s/ John P. Hyland
------------------
John P. Hyland
Chief Executive Officer and President
(principal executive officer)
24
CERTIFICATION
I, Patrick J. Hunt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Security
Financial Bancorp, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's Board of Directors (or persons
performing the equivalent function):
a. All significant deficiencies in the design or operation of
the internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 14, 2003 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
25