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, 2003
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 [ ]
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 May 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 March 31, 2003
and June 30, 2002 3
Consolidated Statements of Income for the Three and Nine
Months Ended March 31, 2003 and 2002 4 and 5
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended March 31, 2003 6
Consolidated Statements of Cash Flows for the Nine Months
Ended March 31, 2003 and 2002 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis and Results
of Operations 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk 19
Item 4. Controls and Procedures 21
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 25
2
PART I--FINANCIAL INFORMATION FOR
SECURITY FINANCIAL BANCORP, INC.
Item 1. Financial Statements.
---------------------
SECURITY FINANCIAL BANCORP, INC.
Consolidated Balance Sheets
March 31, 2003 and June 30, 2002
(Unaudited)
(Dollars in thousands)
March 31, June 30,
2003 2002
---- ----
Assets:
Cash and due from financial institutions $ 5,907 $ 5,729
Interest-bearing deposits in financial institutions 56,319 36,515
----------- -----------
Cash and cash equivalents 62,226 42,244
Securities available for sale 24,023 33,980
Loans held for sale 2,652 1,468
Loans receivable, net of allowance for loan losses of $1,387 at
March 31, 2003 and $1,479 at June 30, 2002 92,566 105,489
Federal Home Loan Bank stock 5,300 5,300
Cash surrender value of life insurance policies 6,717 6,489
Other real estate owned 523 129
Premises and equipment, net 4,456 4,681
Accrued interest receivable and other assets 1,328 1,412
----------- -----------
Total assets $ 199,791 $ 201,192
=========== ===========
Liabilities and Stockholders' Equity:
Liabilities:
Demand, NOW and money market deposits $ 22,064 $ 21,615
Savings 49,148 45,650
Time deposits 76,357 81,028
----------- -----------
Total deposits 147,569 148,293
Federal Home Loan Bank advances 15,000 15,000
Advances from borrowers for taxes and insurance 316 197
Accrued interest and other liabilities 293 760
----------- -----------
Total liabilities 163,178 164,250
Stockholders' Equity:
Common stock 19 19
Additional paid-in capital 18,701 18,610
Unearned ESOP (1,215) (1,293)
Unearned stock awards (768) (955)
Treasury stock (1,469) (1,459)
Retained earnings, substantially restricted 21,180 21,891
Accumulated other comprehensive income 165 129
----------- -----------
Total stockholders' equity 36,613 36,942
----------- -----------
Total liabilities and stockholders' equity $ 199,791 $ 201,192
=========== ===========
See accompanying notes to consolidated financial statements.
3
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Three Months Ended March 31, 2003 and 2002
(Unaudited)
(In thousands, except per share data)
2003 2002
---- ----
Interest and dividend income:
Loans, including fees $ 1,554 $ 2,003
Securities 375 685
Other interest-earning assets 149 118
----------- -----------
Total interest income 2,078 2,806
Interest expense:
Deposits 699 990
Federal Home Loan Bank advances 189 190
----------- -----------
Total interest expense 888 1,180
----------- -----------
Net interest income 1,190 1,626
Provision for loan losses - 45
----------- -----------
Net interest income after provision for loan losses 1,190 1,581
Noninterest income:
Service charges and other fees 85 66
Loan charges and servicing fees 40 53
Gain on sale of loans from secondary market activities 113 59
Gain on sale of other real estate owned 9 2
Increase in cash surrender value of life insurance 71 75
Other 119 112
----------- -----------
Total noninterest income 437 367
Noninterest expense:
Compensation and benefits 1,172 824
Occupancy and equipment 271 264
Advertising and promotions 22 37
Data processing 66 24
Legal fees 219 32
Other 563 285
----------- -----------
Total noninterest expense 2,313 1,466
----------- -----------
Income (loss) before income taxes (686) 482
Income tax expense (benefit) (199) 165
----------- -----------
Net income (loss) $ (487) $ 317
=========== ===========
Earnings (loss) per share - basic and diluted $ (.29) $ .19
Comprehensive income (loss) $ (543) $ 172
See accompanying notes to consolidated financial statements.
4
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Income
For the Nine Months Ended March 31, 2003 and 2002
(Unaudited)
(In thousands, except per share data)
2003 2002
---- ----
Interest and dividend income:
Loans, including fees $ 5,079 $ 6,338
Securities 1,322 2,383
Other interest-earning assets 432 497
----------- -----------
Total interest income 6,833 9,218
Interest expense:
Deposits 2,355 3,629
Federal Home Loan Bank advance 577 576
Borrowed funds - 2
----------- -----------
Total interest expense 2,932 4,207
----------- -----------
Net interest income 3,901 5,011
Provision for loan losses 10 135
----------- -----------
Net interest income after provision for loan losses 3,891 4,876
Noninterest income:
Service charges and other fees 266 227
Loan charges and servicing fees 157 168
Gain on sale of loans from secondary market activities 326 159
Gain on sale of other real estate owned 15 42
Increase in cash surrender value of life insurance 228 248
Other 346 352
----------- -----------
Total noninterest income 1,338 1,196
Noninterest expense:
Compensation and benefits 3,628 2,470
Occupancy and equipment 768 868
Advertising and promotions 83 94
Data processing 176 179
Legal fees 569 662
Other 1,145 882
----------- -----------
Total noninterest expense 6,369 5,155
----------- -----------
Income (loss) before income taxes (1,140) 917
Income tax expense (benefit) (429) 266
----------- -----------
Net income (loss) $ (711) $ 651
=========== ===========
Earnings (loss) per share - basic $ (.42) $ .38
Earnings (loss) per share - diluted $ (.42) $ .37
Comprehensive income (loss) $ (675) $ 604
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, 2003
(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 - 91 78 - 169
Stock awards earned 177 177
Forfeited stock awards 10 (10) -
Comprehensive loss:
Net loss (711) (711)
Change in unrealized loss
on securities available-
for-sale 36 36
--------
Total comprehensive
Income (loss) (675)
--------- --------- --------- --------- --------- --------- -------- --------
Balance at March 31,
2003 $ 19 $ 18,701 $ (1,215) $ (768) $ 21,180 $ 165 $ (1,469) $ 36,613
========= ========= ========= ========= ========= ========= ======== ========
See accompanying notes to consolidated financial statements.
6
SECURITY FINANCIAL BANCORP, INC.
Consolidated Statements of Cash Flows
For Nine Months Ended March 31, 2003 and 2002
(Unaudited)
(In thousands)
2003 2002
---- ----
Cash flows from operating activities:
Net income (loss) $ (711) $ 651
Adjustments to reconcile net income (loss) to net cash from
operating activities:
Depreciation 266 358
Provision for loan losses 10 135
Gain on other real estate owned (15) (42)
Origination and purchase of loans held for sale (29,312) (11,748)
Proceeds from sales of loans held for sale 28,454 12,112
Gain on sale of loans for secondary market (326) (159)
ESOP expense 169 151
Stock award expense 177 174
Net amortization (accretion) on securities 403 (169)
Increase in cash surrender value of life insurance (228) (248)
Change in accrued interest receivable and other assets 59 1,123
Change in accrued interest payable and other liabilities (467) (1,428)
----------- -----------
Net cash from operating activities (1,521) 910
Cash flows from investing activities:
Proceeds from maturities and calls of securities available for sale 39,687 41,321
Principal payments on securities available for sale 189 1,334
Purchase of securities available for sale (30,261) (33,369)
Change in loans 12,114 8,523
Change in premises and equipment, net (41) (46)
Proceeds from sale of other real estate 420 121
----------- -----------
Net cash from investing activities 22,108 17,884
Cash flows from financing activities:
Change in deposits (724) (1,410)
Change in advance payments by borrowers for taxes and insurance 119 (5)
Repayments of other borrowed funds - (75)
Purchase of treasury stock - (2,756)
----------- -----------
Net cash from financing activities (605) (4,246)
----------- -----------
Net increase in cash and cash equivalents 19,982 14,548
Cash and cash equivalents at beginning of period 42,244 26,501
----------- -----------
Cash and cash equivalents at end of period $ 62,226 $ 41,049
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 2,938 $ 4,247
Taxes 220 420
Transfer from loans to foreclosed real estate 799 61
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, 2003
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 March 31,
2003 and 2002:
2003 2002
---- ----
Basic
Net income (loss) $ (487) $ 317
========= =========
Weighted average common shares outstanding 1,695 1,674
========= =========
Basic earnings (loss) per common share $ (.29) $ .19
========= =========
8
2003 2002
---- ----
Diluted
Net income (loss) $ (487) $ 317
========= =========
Weighted average common shares outstanding 1,695 1,674
Diluted effect of stock options and stock awards - 28
--------- ---------
Diluted average common shares 1,695 1,702
========= =========
Diluted earnings (loss) per share $ (.29) $ .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,
2003 and 2002:
2003 2002
---- ----
Basic
Net income (loss) $ (711) $ 651
========= =========
Weighted average common shares outstanding 1,689 1,721
========= =========
Basic earnings (loss) per common share $ (.42) $ .38
========= =========
Diluted
Net income (loss) $ (711) $ 651
========= =========
Weighted average common shares outstanding 1,689 1,721
Diluted effect of stock options and stock awards - 23
--------- ---------
Diluted average common shares 1,689 1,744
========= =========
Diluted earnings (loss) per share $ (.42) $ .37
========= =========
Basic and dilutive loss per share were the same for the three and nine
months ended March 31, 2003 as diluted loss per share would be antidilutive.
(4) Stock Compensation
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income (loss) and earnings (loss) per share
if expense was measured using the fair value recognition provisions of FASB
Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION.
9
Three Months Nine Months
Ended March 31 Ended March 31
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss) as reported $ (487) $ 317 $ (711) $ 651
Deduct: Stock-based compensation expense
determined under fair value based method 41 41 122 114
-------- -------- -------- --------
Pro forma net income (loss) $ (528) $ 276 $ (833) $ 537
======== ======== ======== ========
Basic income (loss) per share as reported $ (.29) $ .19 $ (.42) $ .38
Pro forma basic income (loss) per share (.31) .16 (.49) .31
Diluted income (loss) per share as reported (.29) .19 (.42) .37
Pro forma diluted income (loss) per share (.31) .16 (.49) .31
10
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 Quarterly 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. A special meeting of the
stockholders of Security Financial Bancorp, Inc. is scheduled to be held on June
10, 2003.
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
11
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 nine months ended March 31, 2003
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, 2003 AND JUNE 30, 2002
Total assets decreased by $1.4 million to $199.8 million at March 31, 2003
from $201.2 million at June 30, 2002.
Loans, net of the allowance for loan losses, declined to $92.6 million at
March 31, 2003 from $105.5 million at June 30, 2002, or 12.2%. Residential
mortgage loan balances declined by $12.5 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
originates. Consumer loans declined by $2.6 million as loans from the Bank's
discontinued indirect automobile lending program pay down and internally
generated automobile loans pay down. Commercial loan balances increased by $2.1
million.
Total deposits decreased to $147.6 million at March 31, 2003, from $148.3
million at June 30, 2002, a decline of .5%. Time deposits decreased by $4.7
million, savings accounts increased by $3.5 million, and other deposits
increased by $450,000.
Total stockholders' equity at March 31, 2003 was $36.6 million compared to
$36.9 million at June 30, 2002, a decrease of $329,000. The decrease was
primarily attributable to the net loss of $711,000 for the nine months ended
March 31, 2003. The impact of the net loss was partially offset by $177,000 of
Incentive Plan stock awards earned, $169,000 related to the release of ESOP
shares, and a $36,000 increase in the fair value of securities available for
sale, net of taxes.
12
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND
2002
GENERAL. The net loss for the three-month period ended March 31, 2003 was
$487,000 compared to net income of $317,000 for the comparable period in 2002, a
decrease of $804,000. The decrease was primarily attributable to a decrease in
net interest income after provision for loan losses of $391,000, an increase in
compensation and benefits expense of $349,000, an increase in legal fees of
$187,000 and an increase in other noninterest expense of $276,000. The decrease
was partially offset by a $54,000 increase in gains on the sale of loans from
secondary market activities and a decrease in income tax expense of $364,000.
INTEREST INCOME. Interest income for the quarter ended March 31, 2003 was
$2.1 million compared to $2.8 million for the quarter ended March 31, 2002, a
decrease of $728,000, or 25.9%. The decrease was primarily attributable to a
significant decrease in the yield earned on our interest-earning assets, which
decreased to 4.56% for the three-month period ended March 31, 2003 from 6.32%
for the same period in 2002. The yield earned on the Company's cash balances has
dropped approximately 50 basis points for the compared periods.
INTEREST EXPENSE. Interest expense for the quarter ended March 31, 2003 was
$888,000 compared to $1.2 million for the quarter ended March 31, 2002, a
decrease of $292,000, or 24.7%. 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 1.95%
for the three-month period ended March 31, 2003 from 2.66% for the same period
in 2002. Our cost of funds decreased to 2.26% for the three months ended March
31, 2003 from 3.01% for the three months ended March 31, 2002, reflecting a
general decrease in interest rates from period to period.
NET INTEREST INCOME. Net interest income decreased to $1.2 million for the
three-month period ended March 31, 2003 from $1.6 million, a decrease of
$436,000, or 26.8%. The net interest margin decreased to 2.61% from 3.66% 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 reflect 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 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 the
Company's evaluation of these factors, management made no provision for the
three months ended March 31, 2003 and a provision of $45,000 for the three
months ended March 31, 2002. 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 1.48%, of loans outstanding
at March 31, 2003, as compared with
13
$1.5 million, or 1.38%, of loans outstanding at June 30, 2002. The allowance for
loan losses to non-performing loans was 115.9% at March 31, 2003, 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
March 31, 2003 was maintained at a level that represents management's best
estimate of probable incurred losses in the loan portfolio.
NONINTEREST INCOME. Noninterest income was $437,000 for the three months
ended March 31, 2003 compared to $367,000 for the three-month period ended March
31, 2002, an increase of $70,000, or 19.1%. The increase was primarily
attributable to an increase of $54,000 from gains on the sale of loans from
secondary market activities, a $19,000 increase in deposit service charges, a
$7,000 increase from gains on the sale of other real estate owned and
approximately $7,000 of additional miscellaneous income. The increase was
partially offset by a decrease of $13,000 in loan charges and servicing fees and
a decrease of $4,000 in income from bank owned life insurance.
NONINTEREST EXPENSE. Noninterest expense for the quarter ended March 31,
2003 was $2.3 million compared to $1.5 million for the quarter ended March 31,
2002, an increase of $847,000, or 57.8%. The increase in noninterest expense was
primarily attributable to a $348,000 increase in compensation and benefits
expense, a $187,000 increase in legal fees, a $278,000 increase in other
noninterest expense and a $42,000 increase in data processing expense. The
$348,000 increase in compensation and benefits expense was attributable to
$350,000 of curtailment expense being recorded during the quarter for the
termination of Security Federal's pension plan. The Bank's Board of Directors
ratified withdrawal and termination of participation in the pension plan
effective March 31, 2003. The Company expects that final actual expense figures
for the pension plan will be available during the quarter ending June 30, 2003.
The $187,000 increase in legal fees relates primarily to legal costs associated
with the pending merger with Standard Bancshares, Inc. The $278,000 increase in
other noninterest expense relates to a $172,000 fee paid to the Company's
investment advisor as partial payment for its services in connection with the
pending merger with Standard Bancshares, a $94,000 loss related to suspected
fraud of the Bank, and a $14,000 loss related to a robbery at a Security Federal
branch during the quarter. The Company expects to record additional losses
related to the suspected fraud, however, the Company expects to recover any
losses over $100,000 in the aggregate (including the $94,000 recorded in the
quarter ended March 31, 2003) from its insurer.
INCOME TAXES. The Company recorded an income tax benefit of $198,000 for
the quarter ended March 31, 2003 due to the Company's loss in the quarter. This
compares to income tax expense of $165,000 for the quarter ended March 31, 2002.
14
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED MARCH 31, 2003 AND
2002
GENERAL. The net loss for the nine-month period ended March 31, 2003 was
$711,000 compared to net income of $651,000 for the comparable period in 2002, a
decrease of $1,362,000. The decrease was primarily attributable to a decrease in
net interest income after provision for loan losses of $985,000, an increase in
compensation and benefits expense of $1,158,000, and an increase in other
noninterest expense of $261,000. The decrease was partially offset by a $167,000
increase in gains on the sale of loans from secondary market activities, a
decrease in income tax expense of $695,000, a $100,000 decrease in occupancy and
equipment expense, and a $93,000 decrease in legal expense.
INTEREST INCOME. Interest income for the nine months ended March 31, 2003
was $6.8 million compared to $9.2 million for the nine months ended March 31,
2002, a decrease of $2.4 million, or 25.9%.
The decrease was primarily attributable to a significant decrease in the
yield earned on our interest-earning assets, which decreased to 5.0% for the
nine-month period ended March 31, 2003 from 6.77% for the same period in 2002.
The decrease in interest income due to changes in rate was offset slightly by an
increase in the average balance of interest-earning assets to $182.3 million for
the nine months ended March 31, 2003 from $181.4 million for the same period in
2002. The yield earned on the Company's cash balances has dropped approximately
102 basis points for the compared periods.
INTEREST EXPENSE. Interest expense for the nine months ended March 31, 2003
was $2.9 million compared to $4.2 million for the nine months ended March 31,
2002, a decrease of $1.3 million, or 30.3%. 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 2.16% for the nine-month period ended March 31, 2003 from 3.09% for
the same period in 2002. Our cost of funds decreased to 2.49% for the nine
months ended March 31, 2003 from 3.50% for the nine months ended March 31, 2002,
reflecting a general decrease in interest rates from period to period.
NET INTEREST INCOME. Net interest income decreased to $3.9 million for the
nine-month period ended March 31, 2003 from $5.0 million, a decrease of $1.1
million, or 22.2%. The net interest margin decreased to 2.84% from 3.68% 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. Management made provisions of $10,000 and
$135,000 for the nine months ended March 31, 2003 and 2002, 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 1.48%, of loans outstanding at March 31, 2003, 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 115.9% at March 31, 2003,
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
15
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 March 31, 2003 was maintained
at a level that represents management's best estimate of probable incurred
losses in the loan portfolio.
NONINTEREST INCOME. Noninterest income was $1.3 million for the nine months
ended March 31, 2003 compared to $1.2 million for the nine months ended March
31, 2002, an increase of $142,000, or 11.9%. The increase is primarily
attributable to an increase in gains on the sale of mortgage loans from
secondary market activities of $167,000, and an increase in deposit service
charges of $39,000. These increases were partially offset by a $27,000 decrease
in gains on the sale of other real estate owned, a decrease of $20,000 from
income on bank owned life insurance, a decrease of $11,000 from loan charges and
servicing fees and a $6,000 decrease in other noninterest income.
NONINTEREST EXPENSE. Noninterest expense for the nine months ended March
31, 2003 was $6.4 million compared to $5.2 million for the nine months ended
March 31, 2002, an increase of $1.2 million, or 23.5%. The increase in
noninterest expense was primarily attributable to a $1,158,000 increase in
compensation and benefits expense, and a $263,000 increase in other noninterest
expense. The $1,158,000 increase in compensation and benefits expense was
primarily attributable to a $805,000 payment, during the 2nd fiscal quarter, to
the Company's CEO in exchange for his consent to the termination of his
employment agreements with the Company and the Bank and $350,000 of estimated
expense being recorded during the 3rd fiscal quarter for the termination of
Security Federal's pension plan effective March 31, 2003. The Company expects
that final actual expense figures for the pension plan will be available during
the quarter that ends June 30, 2003. The $263,000 increase in other noninterest
expense relates primarily to a $172,000 fee paid to The Company's investment
advisor as partial payment for its services in connection with the pending
merger with Standard Bancshares, a $94,000 loss related to suspected fraud on a
customer account, and a $14,000 robbery loss at a Security Federal branch during
the 3rd fiscal quarter. The Company expects to record additional losses related
to the suspected fraud, however, the Company expects to recover any losses over
$100,000 in the aggregate (including the $94,000 recorded in the quarter ended
March 31, 2003) from its insurer. These increases in noninterest expense were
partially offset by $100,000 decrease in occupancy and equipment expense, a
$93,000 decrease in legal fees and an $11,000 decrease in advertising expense.
INCOME TAXES. The Company recorded an income tax benefit of $429,000 for
the nine months ended March 31, 2003, due to the Company's loss in the current
fiscal period. This compares to income tax expense of $266,000 for the nine
months ended March 31, 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
16
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 operating activities were $663,000 and provided
by operating activities were $910,000 for the nine months ended March 31, 2003
and 2002. 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, 2003, cash and
cash equivalents totaled $62.2 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, 2003, 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 March 31, 2003, the Company had outstanding commitments to originate
loans of $16.9 million. Of this total, $16.5 million had fixed rates and
$400,000 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, 2003
totaled $68.2 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 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).
17
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, 2003:
Total capital
(to risk-
weighted
assets) $ 31,410 27.3% $ 9,199 8.0% $ 11,499 10.0%
Tier 1 capital
(to risk-
weighted
assets) 30,238 26.3 4,600 4.0 6,899 6.0
Core capital
(to adjusted
assets) 30,238 15.2 7,947 4.0 9,934 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
18
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
In an attempt to manage its exposure to changes in interest rates,
management monitors Security Federal's interest rate risk. The Board of
Directors reviews at least quarterly Security Federal's interest rate risk
position and profitability. The Board of Directors also reviews Security
Federal's portfolio, formulates investment strategies, and oversees the timing
and implementation of transactions to ensure attainment of Security Federal's
objectives in the most effective manner. In addition, the Board reviews on a
quarterly basis Security Federal's asset/liability position, including
simulations of the effect on Security Federal's capital of various interest rate
scenarios.
In managing its asset/liability mix, Security Federal, depending on the
relationship between long- and short-term interest rates, market conditions, and
consumer preference, often places more emphasis on managing short-term net
interest margin than on better matching the interest rate sensitivity of its
assets and liabilities in an effort to enhance net interest income. Management
believes that the increased net interest income resulting from a mismatch in the
maturity of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide high enough returns to justify the increased
exposure to sudden and unexpected increases in interest rates.
The Board has taken a number of steps to manage Security Federal's
vulnerability to changes in interest rates. First, Security Federal uses
customer service and marketing efforts to increase Security Federal's
noncertificate accounts. At March 31, 2003, $71.2 million, or 48%, 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 49.6% 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 March 31, 2003,
$3.9 million, or 16%, of Security Federal's securities had terms to maturity of
five years or less based on their carrying value in addition to Security
Federal's mortgage-backed securities, which provide for regular principal
repayments.
The Office of Thrift Supervision provides the Company with the information
presented in the following table. It presents the change in the Company's net
portfolio value at 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.
19
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 $ 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.
20
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
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.
21
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)
22
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
99.0 Certifications required pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-------------------------------------------------
(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 12, 2003.
(8) Incorporated herein by reference from the exhibits to the
Quarterly Report on Form 10-Q filed on February 14, 2003.
(b) Reports on Form 8-K.
On February 13, 2003, the Company filed a Current Report on
Form 8-K disclosing that 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
23
Standard. The Agreement and the press release announcing the
merger agreement were attached as exhibits to the Form 8-K.
24
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, 2003 By: /s/ John P. Hyland
------------------
John P. Hyland
President and Chief Executive
Officer
Date: May 15, 2003 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
25
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 officer 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: May 15, 2003 By: /s/ John P. Hyland
------------------
John P. Hyland
Chief Executive Officer and President
(principal executive officer)
26
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 officer 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: May 15, 2003 By: /s/ Patrick J. Hunt
-------------------
Patrick J. Hunt
Executive Vice President and Chief
Financial Officer
27