SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
------------------
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF
1934 For the quarterly period ended September 30, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the transition period ..... to .....
Commission file number: 0-15624
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SECOND BANCORP INCORPORATED
(exact name of registrant as specified in its charter)
Ohio 34-1547453
--------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
108 Main Ave. S. W. Warren, Ohio 44482-1311
-------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
330.841.0123
-------------
Registrant's telephone number, including area code
Not applicable
--------------
Former name, former address and former fiscal year, if changed 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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------------- ------------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, without par value - 9,994,998 shares outstanding as of October 31,
2001.
Page 1 of 17
SECOND BANCORP INCORPORATED AND SUBSIDIARIES
INDEX Page
Number
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PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated balance sheets -
September 30, 2001 and 2000 and December 31, 2000..........................3
Consolidated statements of income -
Three and nine months ended September 30, 2001 and 2000....................4
Consolidated statements of comprehensive income -
Three and nine months ended September 30, 2001 and 2000................... 5
Consolidated statements of shareholders' equity -
Nine months ended September 30, 2001 and 2000..............................6
Consolidated statements of cash flows -
Nine months ended September 30, 2001 and 2000..............................7
Notes to consolidated financial statements - September 30, 2001............ 8-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ......................10-14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................15
Item 2. Changes in Securities......................................15
Item 3. Defaults upon Senior Securities............................15
Item 4. Submission of Matters to a Vote of Security
Holders....................................................15
Item 5. Other Information .........................................15
Item 6. Exhibits and Reports on Form 8-K ........................ 16
SIGNATURES ........................................................ 17
Exhibit 4.1. Indenture for Subordinated Debentures due 2031 of
Second Bancorp Incorporated dated September 28, 2001,
by and between Second Bancorp Incorporated and
Wilmington Trust Company, as indenture trustee
Exhibit 4.2. Amended and Restated Trust Agreement of Second
Bancorp Capital Trust I, dated September 28, 2001, by
and among Second Bancorp Incorporated, as depositor,
Wilmington Trust Company, as property trustee,
Wilmington Trust Company, as Delaware trustee, and the
administrative trustees named therein.
Exhibit 4.3. Preferred Securities Guarantee Agreement, dated
September 28, 2001, by and between Second Bancorp
Incorporated and Wilmington Trust Company
Exhibit 11. Statement Re: Computation of Earnings Per Share
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Second Bancorp Incorporated and Subsidiaries
Consolidated Balance Sheets
September 30 December 31 September 30
---------------------------------------------------
(Dollars in thousands) 2001 2000 2000
-------------------------------------------------------------------------------------------------------
ASSETS
----------------------------------------------------
Cash and due from banks $32,441 $35,272 $34,079
Federal funds sold and temporary investments 51,233 0 8,000
Trading account 0 328 447
Securities:
Available-for-sale (at market value) 407,004 382,098 400,176
Loans 1,060,741 1,070,089 1,059,530
Less reserve for loan losses 15,392 15,217 15,040
---------------------------------------------------
Net loans 1,045,349 1,054,872 1,044,490
Premises and equipment 16,650 18,039 17,798
Accrued interest receivable 10,272 11,181 10,630
Goodwill and intangible assets 8,328 6,038 6,193
Other assets 37,742 38,462 39,804
---------------------------------------------------
Total assets $1,609,019 $1,546,290 $1,561,617
===================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
----------------------------------------------------
Deposits:
Demand - non-interest bearing $111,539 $110,045 $107,391
Demand - interest bearing 94,831 87,268 83,991
Savings 234,601 246,056 262,024
Time deposits 616,320 592,766 630,971
---------------------------------------------------
Total deposits 1,057,291 1,036,135 1,084,377
Federal funds purchased and securities sold under
agreements to repurchase 110,071 129,895 116,707
Note payable 0 1,000 0
Other borrowed funds 5,745 2,163 3,622
Federal Home Loan Bank advances 267,301 251,733 238,872
Accrued expenses and other liabilities 11,185 8,167 6,020
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust 26,660 0 0
---------------------------------------------------
Total liabilities 1,478,253 1,429,093 1,449,598
Shareholders' equity:
Common stock, no par value; 30,000,000 shares
authorized; 10,828,310, 10,787,310 and 10,776,870
shares issued, respectively 37,424 36,935 36,952
Treasury stock; 801,512, 730,200 and
639,920 shares, respectively (15,072) (13,947) (12,590)
Other comprehensive income 6,850 281 (3,849)
Retained earnings 101,564 93,928 91,506
---------------------------------------------------
Total shareholders' equity 130,766 117,197 112,019
---------------------------------------------------
Total liabilities and shareholders'
equity $1,609,019 $1,546,290 $1,561,617
===================================================
See notes to consolidated financial statements.
-3-
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Income
For the Three Months For the Nine Months
(Dollars in thousands, Ended September 30 Ended September 30
----------------------------- ----------------------------
except per share data) 2001 2000 2001 2000
---------------------------------------------------------------------------------- ----------------------------
INTEREST INCOME
-----------------------------------------------------
Loans (including fees):
Taxable $21,015 $23,367 $64,867 $67,790
Exempt from federal income taxes 268 285 835 738
Securities:
Taxable 5,471 5,419 15,898 15,389
Exempt from federal income taxes 800 777 2,348 2,436
Federal funds sold and other 326 46 815 155
----------------------------- ----------------------------
Total interest income 27,880 29,894 84,763 86,508
INTEREST EXPENSE
-----------------------------------------------------
Deposits 10,467 12,216 33,128 34,407
Federal funds purchased and securities
sold under agreements to repurchase 937 1,440 3,177 3,980
Note payable 13 0 47 19
Other borrowed funds 23 46 75 147
Federal Home Loan Bank advances 3,946 4,586 11,628 11,286
Corporation-obligated mandatorily redeemable
capital securities of subsidiary trust 21 0 21 0
----------------------------- ----------------------------
Total interest expense 15,407 18,288 48,076 49,839
----------------------------- ----------------------------
Net interest income 12,473 11,606 36,687 36,669
Provision for loan losses 988 4,843 3,091 6,226
----------------------------- ----------------------------
Net interest income after
provision for loan losses 11,485 6,763 33,596 30,443
NON-INTEREST INCOME
-----------------------------------------------------
Service charges on deposit accounts 1,344 1,163 3,878 3,296
Trust fees 761 833 2,266 2,886
Gain (loss) on sale of loans 1,394 (3,191) 3,283 (2,491)
Trading account (losses) gains (52) (28) 19 (345)
Security gains (losses) 123 (2,802) 640 (2,497)
Other operating income 921 1,167 3,595 3,542
----------------------------- ----------------------------
Total non-interest income 4,491 (2,858) 13,681 4,391
NON-INTEREST EXPENSE
-----------------------------------------------------
Salaries and employee benefits 5,313 5,421 15,603 15,926
Net occupancy 1,001 1,062 3,179 3,151
Equipment 1,038 1,044 3,008 2,990
Professional services 320 1,650 1,060 2,825
Assessment on deposits and other taxes 415 423 1,221 1,261
Amortization of goodwill and other intangibles 81 216 242 447
Other operating expenses 1,914 3,324 5,625 7,268
----------------------------- ----------------------------
Total non-interest expense 10,082 13,140 29,938 33,868
----------------------------- ----------------------------
Income (loss) before federal income taxes 5,894 (9,235) 17,339 966
Income tax expense (benefit) 1,493 (3,690) 4,492 (1,138)
----------------------------- ----------------------------
Net income (loss) before cumulative effect of
accounting change $4,401 ($5,545) $12,847 $2,104
============================= ============================
Cumulative effect of accounting change - FAS133 0 0 (101) 0
----------------------------- ----------------------------
Net income (loss) $4,401 ($5,545) $12,746 $2,104
============================= ============================
NET INCOME (LOSS) PER COMMON SHARE:
Basic - before cumulative effect of
accounting change $0.44 ($0.55) $1.28 $0.20
Diluted - before cumulative effect of
accounting change $0.43 ($0.55) $1.27 $0.20
Basic $0.44 ($0.55) $1.27 $0.20
Diluted $0.43 ($0.55) $1.26 $0.20
Weighted average common shares outstanding:
Basic 10,033,365 10,161,386 10,021,471 10,294,922
Diluted 10,117,705 10,161,386 10,087,935 10,318,413
See notes to consolidated financial statements.
-4-
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Three Months For the Nine Months
(Dollars in thousands, Ended September 30 Ended September 30
-------------------------- --------------------------
except per share data) 2001 2000 2001 2000
------------------------------------------------------------------------------ --------------------------
Net income (loss) $4,401 $(5,545) $12,746 $2,104
Other comprehensive income, net of tax:
Change in other comprehensive income - deferred
compensation plan
12 - (59) -
Change in unrealized market value adjustment
on securities available-for-sale
5,028 4,782 6,628 3,942
-------------------------- --------------------------
Total other comprehensive income
5,040 4,782 6,569 3,942
-------------------------- --------------------------
Comprehensive income (loss) $9,441 $(763) $19,315 $6,046
========================== ==========================
See notes to consolidated financial statements.
-5-
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Other
Common Treasury Comprehensive Retained
(Dollars in thousands) Stock Stock Income Earnings Total
-------------------------------------------------------------------------------------------------------------
Balance, January 1, 2000 $36,966 $ (7,140) $(7,791) $94,312 $ 116,347
Net income 2,104 2,104
Change in unrealized market value adjustment
on securities available-for-sale, net of 3,942 3,942
tax of $2,123
Cash dividends declared: common ($.48 per share) (4,910) (4,910)
Purchase of treasury shares (5,450) (5,450)
Common stock issued - dividend reinvestment plan (14) (14)
---------------------------------------------------------
Balance, September 30, 2000 $36,952 $(12,590) $(3,849) $ 91,506 $112,019
=========================================================
Balance, January 1, 2001 $36,935 $(13,947) $ 281 $ 93,928 $117,197
Net income 12,746 12,746
Change in other comprehensive income - deferred
compensation plan, net of tax of $(31) (59) (59)
Change in unrealized market value adjustment
on securities available-for-sale, net of 6,628 6,628
tax of $3,573
Cash dividends declared: common ($.51 per share) (5,110) (5,110)
Purchase of treasury shares (1,125) (1,125)
Common stock issued -
stock options and dividend reinvestment plan 489 489
---------------------------------------------------------
Balance, September 30, 2001 $37,424 $(15,072) $6,850 $101,564 $130,766
=========================================================
See notes to consolidated financial statements.
-6-
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Cash Flows
For the Nine Months Ended
(Dollars in thousands) September 30 September 30
Operating Activities 2001 2000
--------------------------------------------------------------------------------------
Net income $12,746 $2,104
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 3,091 6,226
Depreciation expense 2,556 2,639
Amortization of goodwill and other
intangibles 242 447
Net (increase) in servicing rights (2,532) (709)
(Accretion) amortization of investment discount
and premium (316) 173
Deferred income taxes (338) 138
Securities (gains) losses (640) 2,497
Other (gains) losses, net (3,279) 2,489
Net decrease (increase) in trading account
securities 328 (447)
Decrease (increase) in interest receivable 909 (1,353)
(Decrease) increase in interest payable (542) 422
Originations of loans held-for-sale (295,166) (58,167)
Proceeds from sale of loans held-for-sale 298,449 55,678
Net change in other assets & other liabilities 992 (3,078)
------------------------------
Net cash provided by operating activities 16,500 9,059
Investing Activities
--------------------------------------------------
Proceeds from maturities of securities -
available-for-sale 93,400 23,850
Proceeds from sales of securities -
available-for-sale 76,420 105,167
Purchases of securities - available-for-sale (183,575) (158,218)
Net decrease in loans 6,432 9,777
Net increase in premises and equipment (1,171) (1,862)
------------------------------
Net cash used by investing activities (8,494) (21,286)
Financing Activities
--------------------------------------------------
Net decrease in demand deposits, interest bearing
demand and savings deposits (2,398) (18,519)
Net increase in time deposits 23,554 5,307
Net (decrease) increase in federal funds
purchased and securities sold under agreements to
repurchase (19,824) 10,175
Decrease in note payable (1,000) (4,000)
Net increase (decrease) in borrowings 3,582 (2,117)
Net advances from Federal Home Loan Bank 15,568 38,596
Issuance of corporation-obligated mandatorily
redeemable capital securities of subsidiary trust 26,660 0
Cash dividends (5,110) (4,910)
Purchase of treasury stock (1,125) (5,450)
Issuance of common stock 489 (14)
------------------------------
Net cash provided by financing activities 40,396 19,068
------------------------------
Increase in cash and cash equivalents 48,402 6,841
------------------------------
Cash and cash equivalents at beginning of year 35,272 35,238
------------------------------
Cash and cash equivalents at end of period $83,674 $42,079
==============================
Supplementary Cash Flow Information:
Cash paid for 1) Federal income taxes - $3,850,000 and $2,810,000 for the nine
months ended September 30, 2001 and 2000, respectively and 2) Interest -
$48,618,000 and $50,261,000 for the nine months ended September 30, 2001 and
2000, respectively.
See notes to consolidated financial statements.
-7-
Second Bancorp Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
September 30, 2001
(Dollars in thousands)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine-month period ended September 30, 2001 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2001. Certain reclassifications have been made to amounts previously reported
in order to conform to current period presentations. For further information,
refer to the consolidated financial statements and footnotes thereto included
in the Company's Annual Report on Form 10-K for the year ended December 31,
2000.
NOTE 2 - COMPREHENSIVE INCOME
During the first nine months of 2001 and 2000, total comprehensive income
amounted to $9,874 and $6,809, respectively. The components of comprehensive
income, net of tax, for the nine-month periods ended September 30, 2001 and 2000
are as follows:
2001 2000
------------------
Net income $12,746 $2,104
Change in other comprehensive income -
deferred compensation plan (59) 0
Unrealized gains on available-for-sale securities 6,628 3,942
------------------
Comprehensive income $19,315 $6,046
==================
Accumulated other comprehensive income, net of related tax, at September 30,
2001 totaled $6,850 and was comprised of accumulated changes in unrealized
market value adjustments on securities available-for-sale, net of tax and
deferred supplemental income, net of tax. Accumulated other comprehensive income
and loss, net of related tax, at December 31, 2000 and September 30, 2000
totaled $281 and $(3,849), respectively, and was comprised entirely of
accumulated changes in unrealized market value adjustments on securities
available-for-sale, net of tax. Disclosure of reclassification amounts:
NINE MONTHS ENDED
---------------------------------
SEPT. 30, 2001 SEPT. 30, 2000
------------------------------
Unrealized holding gains (losses) arising during the period $ 7,044 $2,319
Less: reclassification of (gains) losses included in
net income, net of tax (416) 1,623
------------------------
Net unrealized gains on available-for-sale securities $ 6,628 $3,942
========================
-8-
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standard Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activity" as amended in June 1999 by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," and in June 2000, by SFAS 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities, "
(collectively SFAS No. 133). SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
imbedded in other contracts, and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as a
hedge. The accounting for changes in the fair value of derivative (gains and
losses) depends on the intended use of the derivative and resulting designation.
On January 1, 2001, the Corporation adopted SFAS No. 133 resulting in a
cumulative effect of accounting change transition adjustment of $(101), after
tax. The impact on 2001 operating results is not considered to be material.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations", and No.
142, "Goodwill and Other Intangible Assets", effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill and intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests in accordance with the Statements. Other
intangible assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Application of the
nonamortization provisions of the Statement to existing goodwill and indefinite
lived intangible assets is expected to result in an increase in net income of
$103 ($.01 per share) per year. Additionally, goodwill arising out of the
recently completed acquisition of Commerce Exchange Corporation will not be
amortized. The amount of the impact of the nonamortization of this goodwill has
yet to be determined. During 2002, the Company will perform the first of the
required impairment tests of goodwill and intangible assets deemed to have
indefinite lives as of January 1, 2002 and has not yet determined what the
effect of these tests will be on the earnings and financial position of the
Company.
NOTE 4 - ACQUISITION OF COMMERCE EXCHANGE CORPORATION AND ISSUANCE OF TRUST
PREFERRED SECURITIES AND SUBORDINATED DEBENTURES
On October 25, 2001 the Company completed the acquisition of Commerce Exchange
Corporation located in Beachwood, Ohio. The all-cash transaction is structured
as a purchase for accounting purposes and, excluding transaction costs, is
expected to be modestly accretive to earnings per share in the first year.
Commerce Exchange Corporation's subsidiary, Commerce Exchange Bank, was merged
into Second National Bank. The two Commerce Exchange Bank offices in Beachwood
and North Olmsted, Ohio are now operated as Second National retail banking
centers.
On September 28, 2001, the Company sold, through Second Bancorp Capital Trust I
(a newly formed subsidiary), $32 million of 9.00% corporation-obligated
manditorily redeemable capital securities of subsidiary trust ("Trust Preferred
Securities"). The Trust issued $28 million in Trust Preferred Securities on
September 28, 2001 and the remaining $4 million Trust Preferred Securities were
issued on October 12, 2001 pursuant to the exercise of an underwriters'
over-allotment option. The proceeds of the offering of the Trust Preferred
Securities were used by the Trust to purchase, from the Company, Subordinated
Debentures due December 31, 2031. The Company used the proceeds from the
offering of the Subordinated Debentures to fund the $26.9 acquisition cost for
Commerce Exchange Corporation. The remaining net proceeds are being used to
repay outstanding debt and to fund the Company's continuing repurchase of its
common stock. The effect of the Trust Preferred Securities Offering will impact
several key performance indicators of the Company's future financial results.
Among those ratios impacted will be the net interest margin, which is expected
to decline with the additional of the Trust Preferred Securities.
-9-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Second Bancorp Incorporated is a one-bank holding company headquartered in
Warren, Ohio. Our bank, The Second National Bank of Warren, was originally
established in 1880. Operating through 37 retail banking centers (including the
newly acquired banking centers of Commerce Exchange Bank), we offer a wide range
of commercial and consumer banking and trust services primarily to business and
individual customers in various communities in a nine county area in
northeastern and east-central Ohio. Among other things, our consumer banking
business includes a large and growing mortgage banking function.
On September 28, 2001, Second Bancorp Incorporated issued through Second Bancorp
Capital Trust I, a newly formed subsidiary, 2,800,000 shares of 9.00% Cumulative
Trust Preferred Securities, $10 liquidation amount, in a public offering
underwritten by Stifel, Nicolaus & Company, Incorporated and Sandler O'Neill &
Partners, L.P. as co-representatives for a group of underwriters. The
underwriters were also granted a 30-day option to purchase up to an additional
400,000 Trust Preferred Securities to cover over-allotments. This option was
exercised by the underwriters and an additional 400,000 Trust Preferred
Securities were issued on October 12, 2001.The gross proceeds of the offering of
the Trust Preferred Securities was $32 million.
The Trust Preferred Securities represent undivided beneficial interests in the
assets of Second Bancorp Capital Trust I which was established as a Delaware
business trust for the purpose of issuing the Trust Preferred Securities. The
Trust Preferred Securities mature on December 31, 2031 and are redeemable on or
after December 31, 2006. Proceeds of the offering of the Trust Preferred
Securities were invested by Second Bancorp Capital Trust I in $32,989,700 9.00%
Subordinated Debentures of Second Bancorp Incorporated due December 31, 2031.
Second Bancorp Incorporated used the proceeds received by it to fund the $26.9
million cash price for the acquisition of Commerce Exchange Corporation which
was completed on October 25, 2001. Proceeds in excess of that cash price are
being used by Second Bancorp Incorporated to pay off existing short-term
indebtedness and for other general corporate purposes.
Forward-looking statements
The sections that follow contain certain forward-looking statements (as defined
in the Private Securities Litigation Reform Act of 1995). These forward-looking
statements may involve significant risks and uncertainties. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, actual results may differ materially from the expectations discussed
in these forward-looking statements.
Financial Condition
At September 30, 2001, the Company had consolidated total assets of $1.61
billion, deposits of $1.06 billion and shareholders' equity of $131 million.
Since September 30, 2000, total assets have increased by $47 million or 3%,
primarily as a result of the issuance of the Trust Preferred Securities in
anticipation of the Commerce acquisition. Gross loans have increased nominally
during the past year by $1 million to $1.061 billion as of September 30, 2001.
Consumer lending activities have resulted in a strong increase in outstanding
consumer loan balances, while the sale of the residential mortgage loans has
resulted in a reduction of total residential mortgage loans from a 33%
concentration of total loans as of September 30, 2000 to 30% at the most recent
quarter end. Consumer loans represented 27% of loans at the end of the third
quarter of 2000 versus 30% for the third quarter of 2001. Cash, federal funds
sold and other liquid assets increased by $42 million during the past 12 months
primarily as a result of the issuance of the Trust Preferred Securities.
Subsequently, $26.9 million of the cash was utilized in the fourth quarter of
2001 to fund the Commerce acquisition.
Deposits decreased by $27 million since September 30, 2000 primarily as a result
of decreases in savings account and time deposit balances. Core transaction
account funding, which includes DDA and NOW accounts, increased by $15 million
since September 30, 2000, due to the positive momentum in new account growth
associated with new deposit account offerings, internal sales incentives and
increased advertising. Federal Home Loan Bank advances have increased by $28
million since a year ago, allowing the Company to raise additional longer-term
funding. The Trust Preferred Securities totaled $26.7 million as of September
30, 2001 with an additional $3.8 million issued during the fourth quarter of
2001.
-10-
Since December 31, 2000, total assets have increased by an annualized rate of
5.4%, primarily through an increase in liquid assets. Deposits have increased by
$21 million and now total $1.06 billion. The increase in deposits was
attributable to an increase in core transaction account balances as well as
short-term time deposits. Gross loans have decreased since the end of last year
by $10 million, indicating the effectiveness of the residential real estate line
of business. Although the Company has generated $347 million in new residential
real estate loans, $295 million, or 83% of those loans produced, have been sold
into the secondary market. As a result, residential real estate loan balances
have decreased by $30 million from a year ago.
Results of Operations
Quarterly Comparison
The Company reported net operating income of $4,401,000 for the third quarter of
2001. Net income for the third quarter represented forty-three cents ($.43) per
share on a diluted basis. Operating return on average assets (ROA) and return on
average total shareholders' equity (ROE) were 1.11% and 13.87%, respectively,
for the third quarter of 2001 compared to (1.34%)% and (19.01)% for last year's
third quarter. The third quarter of 2000 was heavily influenced by a major
restructuring of the balance sheet. The restructuring resulted in $9,022,000 in
after-tax restructuring and other charges. Absent those charges, earnings for
the period would have been $3,477,000 or thirty-four cents ($.34) per share.
After tax charges to earnings (losses) during the third quarter of 2000
resulting from the balance sheet restructuring were $1,825,000 on securities
sales; $2,836,000 on mortgage loan sales; $2,665,000 on additions to the loan
loss reserve to reflect the shift in loan mix; $393,000 on Federal Home Loan
Bank advance prepayments; and $1,303,000 on other non-recurring expenses. One of
the effects of the third quarter 2000 restructuring was to minimally shrink the
Company's balance sheet as $130 million in below market, fixed rate loan assets
were sold and $100 million of the proceeds were used to reduce exposure on
higher cost Federal Home Loan Bank advances. Some of the positive net effects of
these actions will be to significantly improve balance sheet flexibility and
liquidity, reduce the earnings drag caused by a large mortgage loan portfolio,
and ease the overall cost of funds. Excluding the restructuring charges,
operating return on average assets (ROA) and return on average total
shareholders' equity (ROE) would have been .84% and 11.92%,
Commercial Lending. Commercial lending activities focus primarily on providing
local independent commercial and professional firms with commercial business
loans and loans secured by owner-occupied real estate. We primarily make secured
and unsecured commercial loans for general business purposes, including working
capital, accounts receivable financing, machinery and equipment acquisition, and
commercial real estate financing. These loans have both fixed and floating
interest rates and typically have maturities of three to seven years. To a
lesser extent, we also make construction loans and finance commercial equipment
leases. Commercial loans comprised approximately 40% of our total loan portfolio
at September 30, 2001. As a result of the Commerce acquisition, the commercial
loan balances (including commercial real estate loans) have increased to $523
million, or 46.6% of gross loans as of October 31, 2001.
Retail Lending. The Company offers a full range of retail loans to individuals,
including the owners and principals of our commercial customers and a wide range
of retail customers in our market area. We offer consumer loans for a variety of
personal financial needs, including home equity, new and used automobiles, boat
loans, credit cards and overdraft protection for checking account customers. At
September 30, 2001, approximately 46% of our consumer loans consisted of
indirect auto loans. Our indirect auto loans are originated through new car
dealers in the local area. Indirect auto originations have decreased
significantly since mid year. New loan originations averaged $6.5 million during
the second quarter of 2001 and $2.25 million during the third quarter of 2001.
The reduction was a result of tighter credit standards being employed. Consumer
loans comprised approximately 30% of our total loan portfolio at September 30,
2001.
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Trust. The trust department is a traditional provider of fiduciary services with
a focus on administration of estates, trusts and qualified employee benefit
plans. During 2000, personal trust accounts and employee benefit accounts
produced approximately 75% and 25% of the total revenues of the department,
respectively. The department began offering a daily valuation service for 401(k)
plans during the third quarter of 2001, which is expected to position the
Company well for future growth in employee benefit assets and revenues. Fee
income is down 8.6% from the third quarter of 2000 due to the reduction in the
amount of assets under management caused by the loss of over $150 million in
accounts and the decline in overall equity values over the period. Our trust
department had approximately $601 million in assets under management at
September 30, 2001.
Mortgage Banking. Our mortgage department underwrites and originates a wide
range of retail mortgage loan products and sells a significant volume of them
primarily on a servicing retained basis. Generally, the loans sold into the
secondary mortgage market make funds available for reuse in mortgage or other
lending activities. The sales generate a net gain (including origination fee
income and deferred origination costs), limit the interest rate risk caused by
holding long-term, fixed-rate loans, and build a portfolio of serviced loans
which generate a recurring stream of fee income. We sold approximately $120
million of loans during the third quarter of 2001, generating a net gain of
$1,358,000. We service $652 million in mortgage loans for others at September
30, 2001.
Asset Quality. The reserve for loan losses represented 1.45% of loans as of
September 30, 2001. The determination of the reserve for loan losses is based on
management's evaluation of the potential losses in the loan portfolio at
September 30, 2001 considering, among other relevant factors, repayment status,
borrowers' ability to repay, collateral and current economic conditions. The
methodology for the provision for loan losses includes analysis of various
economic factors including loan losses and portfolio growth. The provision for
loan losses decreased to $988,000 for the third quarter of 2001 from $4,893,000
during the same period in 2000. Absent the additional $4.1 million provision
associated with the third quarter 2000 restructuring, the provision would have
been $793,000. Total net charge-offs were $1,168,000 for the third quarter of
2001 versus $1,180,000 for the third quarter of 2000. Loan losses are expected
to remain slightly above their historical level of .30% of loans for the
remainder of the year. The reserve was 1.42% of total loans at September 30,
2000. Non-accrual loans have increased over the past year and total $4,273,000
as of September 30, 2001 versus $3,821,000 as of the same date last year.
Similarly, loans past due over 90 days and still accruing totaled $4,693,000 as
of September 30, 2001 versus $3,171,000 as of the same date last year,
reflecting the general economic slowdown in both the national and local
economies. Both the non-accrual and loans past due over 90 days and still
accruing balances are down from the linked quarter ($4,666,000 and $5,415,000,
respectively).
Net Interest Income. Net interest income for the third quarter of 2001 increased
by $867,000 from the same period last year to $12,473,000. The increase was due
to an improved net interest margin, partially offset by a decline in average
earning assets. The net interest margin improved to 3.49% for the third quarter
of 2001 versus 3.14% for the same period in 2000. The reduction in average
interest earning assets during the past 12 months was strongly influenced by the
sale of mortgage loans in the third quarter of 2000.
Non-interest Income. Non-interest income (excluding security gains and losses
and trading activity) totaled $4,420,000. Excluding the restructuring charge for
the loss on the sale of loans, the third quarter 2000 non-interest income would
have been $3,683,000. The improvement came from a variety of sources including:
1) an increase in 15.6% in service charges on deposit accounts attributable to a
revised deposit account structure, fee schedule, collection procedures and an
increase in the number of accounts and 2) an increase in the gain on sale of
loans from $520,000 (excluding restructuring) to $1,394,000 primarily due to
lower mortgage rates and the resulting increase in refinancing activity. Trust
department income is down 8.6% from the third quarter of 2000 due to the
reduction in the amount of assets under management caused by the loss of over
$150 million in accounts and the decline in overall equity values over the
period. Miscellaneous income is down by 21% due to an increase of $475,000 in
the valuation allowance for mortgage servicing rights. The rapid drop in
long-term interest rates has increased prepayment speeds, causing a reduction in
value of the servicing rights. Increasing prepayment speeds are anticipated to
require additional adjustments in the valuation allowance for mortgage servicing
rights in the fourth quarter of 2001.
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Non-interest Expense. Expenses for the third quarter of 2001 were $3,058,000
lower than for the same period in 2000. Even excluding the impact of the third
quarter restructuring, expenses were down $449,000,or 4.3%. Reductions were
realized in all expense categories from a year ago. The Company expects to
continue to focus on cost controls and reductions in the coming quarters.
Year-to-date Comparison:
The Company reported net income of $12,746,000 ($1.26 per diluted share) for the
first nine months of 2001. Income before cumulative effect of accounting change
("operating net income") was $12,847,000 ($1.27 per diluted share),
substantially greater than the net income reported for the same period in 2000.
Excluding the third quarter 2000 restructuring charges, net income would have
been $11,126,000, or $1.08 per diluted share. The following ratio discussion
references operating net income for 2001 and 2000. Return on average assets
(ROA) and return on average total shareholders' equity (ROE) were 1.09% and
13.97%, respectively, for the first nine months of 2001 compared to 0.93% and
12.87% for the same period last year. A strong increase in non-interest income
and a 4.2% reduction in expenses helped increase net income and offset a neutral
net interest margin and an increase of $965,000 in provision for loan losses
from the first nine months of 2000.
Asset Quality. The provision for loan losses increased to $3,091,000 for the
first nine months of 2001 from $2,126,000 during the same period in 2000
(excluding restructuring charges). The increase is due to an increase in
consumer charge-offs, which elevated total charge-offs to $2,879,000 for the
first three quarters of 2001 versus $2,355,000 during the first three quarters
of 2000. Loan losses are expected to remain slightly above their historical
level of .30% of loans for the remainder of the year.
Net Interest Income. Net interest income for the first nine months of 2001 was
nearly unchanged at $36,387,000. The net interest margin held at 3.47% from a
year ago on an operating basis and average earning assets declined by 1.5% from
the first nine months of 2000.
Non-interest Income. Non-interest income (excluding security gains and losses,
trading and restructuring activity) totaled $13,022,000, or 19.0% higher than
the first nine months of 2000. The increase came from a variety of sources
including: 1) an increase of 17.7% in service charges on deposit accounts
attributable to a revised deposit account structure, fee schedule, collection
procedures and an increase in the number of accounts and 2) an increase in the
gain on sale of loans from $1,220,000 to $3,283,000 primarily due to lower
mortgage rates and the resulting increase in refinancing activity. Trust
department income is down 21.5% from the first three quarters of 2000 due to the
reduction in the amount of assets under management caused by the loss of over
$150 million in accounts and the decline in overall equity values over the
period. Security gains for the first nine months of 2001 totaled $640,000 versus
$317,000 for the same period in 2000. Miscellaneous income was virtually
unchanged at $5,625,000 for the first three quarters of 2001, but included an
increase in the valuation allowance for mortgage servicing rights of $505,000.
The rapid drop in long-term interest rates has increased prepayment speeds,
causing a reduction in value of the servicing rights. Increasing prepayment
speeds are anticipated to require additional adjustments in the valuation
allowance for mortgage servicing rights in the fourth quarter of 2001.
Non-interest Expense. Expenses for the first nine months of 2001 were 4.2% lower
than for the same period in 2000. Reductions were realized in all expense
categories except equipment and occupancy, which were 0.6% and 0.9% greater,
respectively. The Company expects to continue to focus on cost controls and
reductions in the coming quarters.
Capital resources. Shareholders' equity has increased by $13.6 million since
December 31, 2000 due to the increase in accumulated other comprehensive income
("OCI"), which increased by nearly $6.6 million since year-end, and the increase
in retained earnings, which increased by $7.6 million since year-end. The
Company has slightly more than 180,000 shares remaining under the present
repurchase authorization. Repurchases under this authorization are expected to
be completed through open market transactions at prevailing market prices and
are discretionary, based upon management's periodic assessment of market
conditions and financial benefit to the Company. This continuing repurchase
authorization will remain in effect until amended or withdrawn by subsequent
board action. As of October 31, 2001, the Company had repurchased 833,312 of
shares of common stock.
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Liquidity. Management of the Company's liquidity position is necessary to ensure
that funds are available to meet the cash flow needs of depositors and borrowers
as well as the operating cash needs of the Company. Funds are available from a
number of sources including maturing securities, payments made on loans, the
acquisition of new deposits, the sale of packaged loans, borrowing from the FHLB
and overnight lines of credit of over $37 million through correspondent banks.
The parent company has three major sources of funding including dividends from
the Bank, $20 million in unsecured lines of credit with correspondent banks,
which are renewable annually, and access to the capital markets. There were no
outstanding balances against the unsecured lines of credit as of September 30,
2001.
Item 3. Qualitative and Quantitative Disclosure About Market Risk
Forward-looking statements
The section that follows contains certain forward-looking statements (as defined
in the Private Securities Litigation Reform Act of 1995). These forward-looking
statements may involve significant risks and uncertainties. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, actual results may differ materially from the expectations discussed
in these forward-looking statements.
Market Risk Management:
Market risk is the risk of economic loss from adverse changes in the fair value
of financial instruments due to changes in (a) interest rates, (b) foreign
exchange rates, or (c) other factors that relate to market volatility of the
rate, index, or price underlying the financial instrument. The Company's market
risk is composed primarily of interest rate risk. The Company's Asset/Liability
Committee (ALCO) is responsible for reviewing the interest rate sensitivity
position of the Company and establishing policies to monitor and limit the
exposure to interest rate risk. Since nearly the Company's entire interest rate
risk exposure relates to the financial instrument activity of the Bank, the
Bank's Board of Directors review the policies and guidelines established by
ALCO.
The primary objective of asset/liability management is to provide an optimum and
stable net interest margin, after-tax return on assets and return on equity
capital, as well as adequate liquidity and capital. Interest rate risk is
monitored through the use of two complementary measures: dynamic gap analysis
and earnings simulation models. While each of the measurement techniques has
limitations, taken together they represent a reasonably comprehensive tool for
measuring the magnitude of interest rate risk inherent in the Company.
The earnings simulation model forecasts earnings for a one-year horizon frame
under a variety of interest rate scenarios; including interest rate shocks,
stepped rates and yield curve shifts. Management evaluates the impact of the
various rate simulations against earnings in a stable interest rate environment.
The most recent model projects net income would increase by 3.1% if interest
rates would immediately rise by 200 basis points. It projects a decrease in net
income of 3.1% if interest rates would immediately fall by 200 basis points.
Management believes this reflects an acceptable level of risk from interest rate
movements. The earnings simulation model includes assumptions about how the
various components of the balance sheet and rate structure are likely to react
through time in different interest rate environments. These assumptions are
derived from historical analysis and management's outlook. Management expects
interest rates to have a neutral to downward bias for the remainder of 2001 and
a neutral bias for the first half of 2002.
Interest rate sensitivity is managed through the use of security portfolio
management techniques, the use of fixed rate long-term borrowings from the FHLB,
the establishment of rate and term structures for time deposits and loans and
the sale of long-term fixed rate mortgages through the secondary mortgage
market. The Company also may use interest rate swaps, caps and floors to manage
interest rate risk.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings -
The Company is subject to various pending and threatened lawsuits in the
ordinary course of business in which claims for monetary damages are asserted.
While any litigation involves an element of uncertainty, in the opinion of
management, liabilities, if any, arising from such litigation or threat thereof
will not have a material impact on the financial position or results of
operations of the Company.
Item 2. Changes in Securities - None
Item 3. Defaults upon Senior Securities - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders - Not applicable
Item 5. Other Information - On September 28, 2001, Second Bancorp Incorporated
issued through Second Bancorp Capital Trust I, a newly formed subsidiary,
2,800,000 shares of 9.00% Cumulative Trust Preferred Securities, $10 liquidation
amount, in a public offering underwritten by Stifel, Nicolaus & Company,
Incorporated and Sandler O'Neill & Partners, L.P. as co-representatives for a
group of underwriters. The underwriters were also granted a 30-day option to
purchase up to an additional 400,000 Trust Preferred Securities to cover
over-allotments. This option was exercised by the underwriters and an additional
400,000 Trust Preferred Securities were issued on October 12, 2001.The gross
proceeds of the offering of the Trust Preferred Securities was $32 million.
The Trust Preferred Securities represent undivided beneficial interests in the
assets of Second Bancorp Capital Trust I which was established as a Delaware
business trust for the purpose of issuing the Trust Preferred Securities. The
Trust Preferred Securities mature on December 31, 2031 and are redeemable on or
after December 31, 2006. Proceeds of the offering of the Trust Preferred
Securities were invested by Second Bancorp Capital Trust I in $32,989,700 9.00%
Subordinated Debentures of Second Bancorp Incorporated due December 31, 2031.
Second Bancorp Incorporated used the proceeds received by it to fund the $26.9
million cash price for the acquisition of Commerce Exchange Corporation which
was completed on October 25, 2001. Proceeds in excess of that cash price are
being used by Second Bancorp Incorporated to pay off existing short-term
indebtedness and for other general corporate purposes. The Trust Preferred
Securities are traded on the Nasdaq National Market under ticker symbol "SECDP".
Item 6. Exhibits and Reports on Form 8-K:
The following exhibits are included herein:
Exhibit 4.1. Indenture for Subordinated Debentures due 2031 of Second
Bancorp Incorporated, dated September 28, 2001, by and between
Second Bancorp Incorporated and Wilmington Trust Company, as
indenture trustee
Exhibit 4.2. Amended and Restated Trust Agreement of Second Bancorp
Capital Trust I, dated September 28, 2001, by and among Second
Bancorp Incorporated, as depositor, Wilmington Trust Company, as
property trustee, Wilmington Trust Company, as Delaware trustee,
and the administrative trustees named therein.
Exhibit 4.3. Preferred Securities Guarantee Agreement, dated September 28,
2001, by and between Second Bancorp Incorporated and
Wilmington Trust Company
Exhibit 11. Statement re: computation of earnings per share
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The Company filed a report on Form 8-K on July 26, 2001 to announce earnings for
the second quarter of 2001. The Company filed a report on Form 8-K on July 26,
2001 to announce the execution of a definitive merger agreement with Commerce
Exchange Corporation. The Company filed a report on Form 8-K on October 1, 2001
to announce the issuance of Trust Preferred Securities. The Company filed a
report on Form 8-K on October 22, 2001 to announce earnings for the third
quarter of 2001. The Company filed a report on Form 8-K on October 30, 2001 to
announce the completion of the acquisition of Commerce Exchange Corporation.
(See Note 4 of the Notes to Consolidated Financial Statements for more
information regarding the acquisition).
-16-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SECOND BANCORP INCORPORATED
Date: November 14, 2001 /s/ David L. Kellerman
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David L. Kellerman, Treasurer
Signing on behalf of the registrant and as principal accounting officer and
principal financial officer.
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