SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT
OF 1934 for the quarterly period ended June 30, 2002
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
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
108 Main Ave. S. W. Warren, Ohio 44482-1311
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(Address of principal executive offices) (Zip Code)
330.841.0123
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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 - 9,940,771 shares outstanding as of June 30,
2002.
1
SECOND BANCORP INCORPORATED AND SUBSIDIARIES
INDEX
Page
Number
------
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated balance sheets -
June 30, 2002 and 2001 and December 31, 2001.......... 3
Consolidated statements of income -
Three and six months ended June 30, 2002 and 2001..... 4
Consolidated statements of comprehensive income -
Three and six months ended June 30, 2002 and 2001..... 5
Consolidated statements of shareholders' equity -
Six months ended June 30, 2002 and 2001............... 6
Consolidated statements of cash flows -
Six months ended June 30, 2002 and 2001............... 7
Notes to consolidated financial statements - June 30, 2002..... 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...... 14-15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 16
Item 2. Changes in Securities.......................................... 16
Item 3. Defaults upon Senior Securities................................ 16
Item 4. Submission of Matters to a Vote of Security
Holders........................................................ 16
Item 5. Other Information.............................................. 16
Item 6. Exhibits and Reports on Form 8-K............................... 16
SIGNATURES ............................................................. 17
Exhibit 11. Statement Re: Computation of Earnings Per Share
Exhibit 99.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Title 18, United States Code, Section
1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Second Bancorp Incorporated and Subsidiaries
Consolidated Balance Sheets
June 30 December 31 June 30
------------------------------------------------------
(Dollars in thousands) 2002 2001 2001
------------------------------------------------------------------------------------------------------------------
ASSETS
------------------------------------------------------------
Cash and due from banks $ 36,230 $ 40,837 $ 36,024
Federal funds sold and temporary investments 64,194 24,016 27,979
Securities:
Trading 0 0 0
Available-for-sale (at market value) 448,736 417,496 380,262
------------------------------------------------------
Total securities 448,736 417,496 380,262
Loans 1,092,398 1,121,892 1,075,039
Less reserve for loan losses 16,810 16,695 15,609
------------------------------------------------------
Net loans 1,075,588 1,105,197 1,059,430
Premises and equipment 16,592 16,416 17,122
Accrued interest receivable 8,724 10,272 9,759
Goodwill and intangible assets 28,415 26,578 7,547
Other assets 41,265 39,544 40,247
------------------------------------------------------
Total assets $1,719,744 $1,680,356 $1,578,370
======================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------------------------------
Deposits:
Demand - non-interest bearing $ 145,006 $ 144,953 $ 109,477
Demand - interest bearing 98,893 105,221 90,077
Savings 394,907 276,628 234,314
Time deposits 507,645 596,329 625,890
------------------------------------------------------
Total deposits 1,146,451 1,123,131 1,059,758
Federal funds purchased and securities sold under
agreements to repurchase 119,867 107,279 117,275
Note payable 0 0 1,000
Other borrowed funds 4,249 5,853 4,981
Federal Home Loan Bank advances 271,930 275,152 261,447
Accrued expenses and other liabilities 10,486 10,200 10,802
Corporation-obligated manditorily redeemable capital
securities of subsidiary trust 30,468 30,442 0
------------------------------------------------------
Total liabilities 1,583,451 1,552,057 1,455,263
Shareholders' equity:
Common stock, no par value; 30,000,000 shares
authorized; 10,932,360, 10,832,810 and 10,802,510
shares issued, respectively 38,822 37,453 37,166
Treasury stock; 991,589, 883,494 and 785,000
shares, respectively (19,462) (16,798) (14,740)
Other comprehensive income 7,265 3,434 1,810
Retained earnings 109,668 104,210 98,871
------------------------------------------------------
Total shareholders' equity 136,293 128,299 123,107
------------------------------------------------------
Total liabilities and shareholders' equity $1,719,744 $1,680,356 $1,578,370
======================================================
See notes to consolidated financial statements.
3
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Income
For the Three Months For the Six Months
(Dollars in thousands, except per share data) Ended June 30 Ended June 30
------------------------------ ------------------------------
2002 2001 2002 2001
-------------------------------------------------------------------------------------- ------------------------------
INTEREST INCOME
--------------------------------------------------------
Loans (including fees):
Taxable $19,965 $21,751 $40,436 $43,852
Exempt from federal income taxes 233 279 476 567
Securities:
Taxable 5,797 5,302 11,119 10,427
Exempt from federal income taxes 715 775 1,489 1,548
Federal funds sold and other 394 298 607 489
------------------------------ ------------------------------
Total interest income 27,104 28,405 54,127 56,883
INTEREST EXPENSE
--------------------------------------------------------
Deposits 7,429 11,192 15,103 22,661
Federal funds purchased and securities
sold under agreements to repurchase 636 1,053 1,202 2,240
Note payable 0 16 0 34
Other borrowed funds 2 15 18 52
Federal Home Loan Bank advances 3,901 3,831 7,778 7,682
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust 733 0 1,466 0
------------------------------ ------------------------------
Total interest expense 12,701 16,107 25,567 32,669
------------------------------ ------------------------------
Net interest income 14,403 12,298 28,560 24,214
Provision for loan losses 1,303 1,342 2,236 2,103
------------------------------ ------------------------------
Net interest income after provision for loan losses 13,100 10,956 26,324 22,111
NON-INTEREST INCOME
--------------------------------------------------------
Service charges on deposit accounts 1,411 1,273 2,731 2,534
Trust fees 696 749 1,482 1,505
Gain on sale of loans 1,709 1,106 3,253 1,889
Trading account gains 0 13 (20) 71
Security gains 0 (12) (173) 517
Other operating income 237 1,502 1,744 2,674
------------------------------ ------------------------------
Total non-interest income 4,053 4,631 9,017 9,190
NON-INTEREST EXPENSE
--------------------------------------------------------
Salaries and employee benefits 6,325 5,096 12,634 10,290
Net occupancy 1,125 1,062 2,262 2,178
Equipment 1,023 921 2,225 1,970
Professional services 443 397 928 740
Assessment on deposits and other taxes 330 405 659 806
Amortization of goodwill and other intangibles 111 80 221 161
Other operating expenses 1,926 1,844 4,151 3,711
------------------------------ ------------------------------
Total non-interest expense 11,283 9,805 23,080 19,856
------------------------------ ------------------------------
Income before federal income taxes 5,870 5,782 12,261 11,445
Income tax expense 1,517 1,524 3,225 2,999
------------------------------ ------------------------------
Net income before cumulative effect of
accounting change $ 4,353 $ 4,258 $ 9,036 $ 8,446
============================== ==============================
Cumulative effect of accounting change - SFAS133 0 0 0 (101)
------------------------------ ------------------------------
Net income $ 4,353 $ 4,258 $ 9,036 $ 8,345
============================== ==============================
NET INCOME PER COMMON SHARE:
Basic - before cumulative effect of accounting n/a n/a n/a $ 0.84
change
Diluted - before cumulative effect of accounting n/a n/a n/a $ 0.84
change
Basic $ 0.44 $ 0.42 $ 0.91 $ 0.83
Diluted $ 0.43 $ 0.42 $ 0.90 $ 0.83
Weighted average common shares outstanding:
Basic 9,958,928 10,007,904 9,948,346 10,013,966
Diluted 10,087,003 10,103,060 10,071,366 10,079,973
See notes to consolidated financial statements.
4
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Three Months For the Six Months
(Dollars in thousands, except per share data) Ended June 30 Ended June 30
-------------------------- --------------------------
2002 2001 2002 2001
------------------------------------------------------------------------------ --------------------------
Net income $ 4,353 $ 4,258 $ 9,036 $8,345
Other comprehensive income, net of tax:
Change in other comprehensive income - SFAS 133 - (490) - -
Change in other comprehensive income - deferred
compensation plan - (71) - (71)
Change in unrealized market value adjustment
on securities available-for-sale 5,841 (1,069) 3,831 1,600
-------------------------- --------------------------
Total other comprehensive income
5,841 (1,630) 3,831 1,529
-------------------------- --------------------------
Comprehensive income $10,194 $ 2,628 $12,867 $9,874
========================== ==========================
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, 2001 $36,935 $(13,947) $281 $93,928 $117,197
Net income 8,345 8,345
Change in other comprehensive income - deferred
compensation plan, net of tax of $(38) (71) (71)
Change in unrealized market value adjustment
on securities available-for-sale, net of tax
of $862 1,600 1,600
Cash dividends declared: common ($.34 per share) (3,402) (3,402)
Purchase of treasury shares (793) (793)
Common stock issued -
stock options and dividend reinvestment plan 231 231
---------------------------------------------------------------------
Balance, June 30, 2001 $37,166 $(14,740) $1,810 $98,871 $123,107
=====================================================================
Balance, January 1, 2002 $37,453 $(16,798) $3,434 $104,210 $128,299
Net income 9,036 9,036
Change in unrealized market value adjustment
on securities available-for-sale, net of tax
of $2,063 3,831 3,831
Cash dividends declared: common ($.36 per share) (3,578) (3,578)
Purchase of treasury shares (2,664) (2,664)
Common stock issued - dividend reinvestment plan 1,369 1,369
---------------------------------------------------------------------
Balance, June 30, 2002 $38,822 $(19,462) $7,265 $109,668 $136,293
=====================================================================
See notes to consolidated financial statements.
6
Second Bancorp Incorporated and Subsidiaries (Dollars in thousands, except per share data)
Consolidated Statements of Cash Flows
For the Six Months Ended
June June
2002 2001
--------------------------------
OPERATING ACTIVITIES
------------------------------------------------------------------------------------
Net income $ 9,036 $ 8,345
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 2,236 2,103
Provision for depreciation 1,845 1,665
Provision for amortization of intangibles 221 161
Amortization of servicing rights 1,121 (1,700)
Accretion of investment discount and premium (142) (143)
Amortization of underwriting costs - corporation-obligated
mandatory redeemable capital securities of subsidiary trust 26 0
Increase in allowance for servicing rights 1,475 30
Deferred income taxes (22) (60)
Securities losses (gains) 173 (517)
Other gains, net (1,709) (1,890)
Net decrease in trading account securities 0 328
Decrease in interest receivable 1,548 1,422
(Decrease) in interest payable (480) (33)
Originations of loans held-for-sale (336,009) (175,077)
Proceeds from sale of loans held-for-sale 337,718 176,966
Net change in other assets & other liabilities (2,990) 14
--------------------------------
Net cash provided by operating activities 14,047 11,614
INVESTING
ACTIVITIES
------------------------------------------------------------------------------------
Proceeds from maturities of securities - available-for-sale 114,595 50,896
Proceeds from sales of securities - available-for-sale 83,346 63,067
Purchases of securities - available-for-sale (223,324) (109,009)
Cash paid for acquisition of Commerce Exchange Corporation, net of cash acquired 0 0
Net decrease (increase) in loans 22,719 (6,661)
Net increase in premises and equipment (2,021) (747)
--------------------------------
Net cash used for investing activities (4,685) (2,454)
FINANCING
ACTIVITIES
------------------------------------------------------------------------------------
Net increase (decrease) demand deposits, interest bearing
demand and savings deposits 112,004 (9,501)
Net (decrease) increase in time deposits (88,684) 33,124
Net increase (decrease) in federal funds purchased
and securities sold under agreements to repurchase 12,588 (12,620)
(Decrease) increase in note payable 0 0
Net (decrease) increase in borrowings (1,604) 2,818
Net (repayments) advances from Federal Home Loan Bank (3,222) 9,714
Issuance of corporation - obligated mandatorily redeemable
capital securities of subsidiary trust 0 0
Cash dividends (3,578) (3,402)
Purchase of treasury stock (2,664) (793)
Net issuance of common stock 1,369 231
--------------------------------
Net cash provided by financing activities 26,209 19,571
--------------------------------
Increase in cash and cash equivalents 35,571 28,731
--------------------------------
Cash and cash equivalents at beginning of year 64,853 35,272
--------------------------------
$ 100,424 $ 64,003
================================
Supplementary Cash Flow Information:
Cash paid for 1) Federal Income taxes - $3,225,000 and $3,025,000 for the six
months ended June 30, 2002 and 2001, respectively and 2) Interest - $23,635,000
and $32,679,000 for the six months ended June 30, 2002 and 2001, respectively.
See notes to consolidated financial statements.
7
Second Bancorp Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (unaudited) June 30, 2002
(Dollars in thousands, except per share data)
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
three- and six-month periods ended June 30, 2002 are not necessarily indicative
of the results that may be expected for the year ended December 31, 2002.
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, 2001.
NOTE 2 - COMPREHENSIVE INCOME
During the first six months of 2002 and 2001, total comprehensive income
amounted to $12,867 and $9,874, respectively. The components of comprehensive
income, net of tax, for the six-month periods ended June 30, 2002 and 2001 are
as follows:
2002 2001
-------------------------
Net income $ 9,036 $ 8,345
Change in other comprehensive income -
deferred compensation plan 0 (71)
Unrealized gains (losses) on available-for-sale securities 3,831 1,600
-------------------------
Comprehensive income $12,867 $ 9,874
=========================
Accumulated other comprehensive income, net of related tax, at June 30, 2002,
December 31, 2001 and June 30, 2001 totaled $7,265, $3,434 and $1,810,
respectively 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. Disclosure of reclassification amounts, net of
tax:
Six Months Ended
----------------------------
June 30, 2002 June 30, 2001
----------------------------
Unrealized holding gains arising during the period $ 3,719 $ 2,117
Less: reclassification of (losses) gains included in net income 112 (517)
----------------------------
Net unrealized gains on available-for-sale securities $ 3,831 $ 1,600
============================
8
(Dollars in thousands, except per share data)
NOTE 3 - INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards 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 indefinite lived intangible
assets will no longer be amortized but will be subject to annual impairment
tests in accordance with the statements. Other intangible assets, such as core
deposit intangibles, will continue to be amortized over their useful lives. The
Company had approximately $14.6 million of goodwill on its balance sheet at
December 31, 2001. In preparing for its adoption of SFAS No. 142, the Company
determined its reporting units and the amounts of goodwill and intangible assets
to be allocated to those reporting units. The initial impairment testing has
been completed and the Company has determined that there was no impairment as of
January 1, 2002. The Company is not anticipating any impairment, any
reclassifications between goodwill and intangible assets or any changes in the
useful lives of intangible assets. No amortization expense is being recorded on
the goodwill in 2002 compared to amortization expense of $93 for the first half
of 2001 and $187 for the year 2001. Application of the non-amortization
provisions of the statement increased net income by $64 or $.00 per share in the
first half of 2002 and is expected to increase net income by $126 or $.01 per
share for the entire year.
Reported net income for the three and six months ended June 30, 2001 was $4,258
and $8,345. Adjusting for the amortization provisions of SFAS No. 142, net
income for the three and six months ended June 30, 2001 would have been $4,286
and $8,402, respectively. Both basic and diluted earnings per share would not
have been affected by the adjustment.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is that amount believed adequate to absorb credit
losses in the loan portfolio based on management's evaluation of various factors
including overall growth in the loan portfolio, an analysis of individual loans,
prior and current loss experience, and current economic conditions. A provision
for loan losses is charged to operations based on management's periodic
evaluation of these and other pertinent factors.
Allowance for loan losses
2002 2001
------------------------------------
Beginning balance, January 1 $16,695 $15,217
Provision
2,236 2,103
Charge-offs
2,910 2,670
Recoveries
789 959
------------------------------------
Net charge-offs
2,121 1,711
------------------------------------
Ending balance, June 30 $16,810 $15,609
====================================
As a percentage of loans 1.54% 1.45%
9
(Dollars in thousands, except per share data)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Second Bancorp Incorporated (the "Company") is a financial holding company
headquartered in Warren, Ohio. The primary subsidiary, The Second National Bank
of Warren, (the "Bank") was originally established in 1880. Operating through 37
retail banking centers, 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. The Company also maintains another subsidiary, Second
Bancorp Capital Trust I, which was established in 2001 to facilitate raising
Tier I eligible capital in the form of corporation-obligated manditorily
redeemable capital securities of subsidiary trust for the primary purpose of
funding our acquisition of Commerce Exchange Bank.
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 June 30, 2002, the Company had consolidated total assets of $1.72 billion,
deposits of $1.15 billion and shareholders' equity of $136 million. Since June
30, 2001, total assets have increased by $141 million or 9%, primarily as a
result of the acquisition of Commerce Exchange Corporation ("Commerce") and its
subsidiary, Commerce Exchange Bank. Total assets of Commerce were $111 million.
Gross loans have increased by $17 million the past year, $93 million from
Commerce. Excluding the impact of the Commerce acquisition, the net reduction in
loans otherwise was primarily the result of reduced balances in real estate
loans. Real estate loans declined by $44 million since June 30, 2001 due to the
increase in refinancing and secondary market sales activities during the past
year. The increased activity levels were brought about by lower long-term
interest rates. A steady increase in direct consumer lending volume has offset
the decline in indirect automobile loan volumes. Indirect loans have been
de-emphasized due to the lower profit margins associated with the credits.
Commercial loans are also undergoing an internal shift away from fixed rate,
real estate based lending to a more variable rate, cash flow based lending
structure. The loan mix has moved from a 40%, 30% and 30% mix of commercial,
consumer and residential real estate loans, respectively, as of June 30, 2001 to
a 44%, 31%, 25% mix at the end of the most recent quarter.
Deposits increased by $70 million since June 30, 2001 primarily as a result of
the acquisition of $87 million in deposits from Commerce. The Bank is also in
the process of de-emphasizing higher cost time deposits as a funding source.
Time deposits have declined by $118 million from a year ago. Savings accounts
have increased by $161 million primarily the result of the introduction of the
Your Best Interest Account, which is an MMDA account with attractive premium
pricing. Demand deposit accounts have increased by $36 million over the same
time period. Approximately 60% of the increase is associated with the Commerce
acquisition, while the remaining 40% is from internal growth. The
corporation-obligated manditorily redeemable capital securities of subsidiary
trust (the "Trust Preferred Securities") used to finance the Commerce
acquisition totaled $30.5 million as of June 30, 2002.
10
(Dollars in thousands, except per share data)
Since March 31, 2002, total assets have increased by $34.9 million. Moderate
loan demand, strong secondary mortgage activities and the internal shift away
from both indirect automobile lending and long-term fixed rate commercial real
estate lending has kept internal loan growth at below normal and historically
sustainable levels. Due to the same reasons as noted above in the year-to-year
analysis, deposits have increased by $15 million during the most recent quarter,
with savings accounts increasing by $59 million and time deposits decreasing by
$51 million.
Asset Quality. The reserve for loan losses represented 1.54% of loans as of June
30, 2002. The determination of the reserve for loan losses is based on
management's evaluation of the potential losses in the loan portfolio at June
30, 2002 considering, among other relevant factors, repayment status, borrowers'
ability to repay, collateral and current economic conditions. The reserve was
1.45% of total loans at June 30, 2001. Non-accrual loans have increased over the
past year and total $6,287 as of June 30, 2002 versus $4,666 as of the same date
last year. Loans past due over 90 days and still accruing totaled $6,011 as of
June 30, 2002, up 11.0% from June 30, 2001, reflecting the general economic
slowdown in both the national and local economies. Approximately 37% of the
loans past due over 90 days and still accruing are residential real estate loans
that are well collateralized and in process of collection with minimal loss
expectations.
Capital resources. Shareholders' equity has increased by $7,994 since December
31, 2001 due to the increase in retained earnings of $5,458 along with an
increase in accumulated other comprehensive income ("OCI") of $3,831. Somewhat
offsetting these increases was the addition of $2,664 in treasury stock. The
Company repurchased more than 108,000 shares during the first half of 2002. The
Company recently authorized an additional 500,000 shares of common stock to be
repurchased. Repurchases under this authorization are expected to be completed
through open market and / or private transactions at prevailing market prices
and are discretionary, based upon management's periodic assessment of market
conditions and financial benefit to the Company. The Company also has an annual
2% repurchase authorization which will remain in effect until amended or
withdrawn by subsequent board action.
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 $33 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 June 30, 2002.
Results of Operations - Quarterly Comparison
The Company reported net income of $4,353 for the second quarter of 2002. Net
income for the second quarter represented forty-three cents ($.43) per share on
a diluted basis. Operating return on average assets (ROA) and return on average
total shareholders' equity (ROE) were 1.01% and 13.12%, respectively, for the
second quarter of 2002 compared to 1.08% and 13.98% for last year's second
quarter. Net interest income increased from $12,298 for the second quarter of
2001 to $14,403 for this year's second quarter. The 17.1% improvement was
primarily the result of an improved net interest margin, which increased to
3.69% for the second quarter 2002 from 3.47% from the second quarter of 2001.
The improvement also partially stemmed from an 9.1% increase in average earning
assets, primarily generated through the Commerce acquisition. The efficiency
ratio was slightly increased, from 56.00% for the second quarter of 2001 to
59.49% for this year's second quarter. Valuation impairment charges on mortgage
servicing rights totaling $1,375 were the primary reason for the increase in the
ratio. There were no valuation adjustments for the second quarter of 2001.
11
(Dollars in thousands, except per share data)
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 44% of our total loan portfolio
at June 30, 2002. Loan volume generated for the second quarter of 2002 totaled
$49.0 million versus $43.7 million for the same period in 2001. Loan balances
have actually declined by $15 million since March 31, 2002 due to the
de-emphasis of long-term fixed rate commercial real estate lending. Many of
those borrowers are refinancing with other institutions at lower rates due to
the current interest rate environment. The portfolio mix continues to shift
towards more rate-sensitive and higher margin, variable rate commercial loans.
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
June 30, 2002, approximately 31% of loans were consumer loans. Of these
balances, 39% were related to indirect automobile, boat and recreational vehicle
lending compared to 48% as of June 30, 2001. Our indirect loans are originated
through dealers in the local area. Indirect originations, which now include
higher quality boat and recreational vehicle loans have decreased from $19.7
million during the second quarter of 2001 to $17.9 million during the second
quarter of 2002. Conversely, direct consumer lending has increased by 33% from
$33.7 million for the second quarter of 2001 to $45.1 million for this year's
second quarter.
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 originated $171 million in
residential real estate loans and sold approximately $155 million of loans
during the second quarter of 2002, generating a net gain of $1,506.
Comparatively, we originated $141 million and sold $115 million during the
second quarter of 2001, generating net gains of $900. We service $1,048 million
in mortgage loans for others at June 30, 2002 versus $652 million as of June 30,
2001. Due to the sharp decline in interest rates in the second quarter of 2002,
the valuation allowance on mortgage servicing rights associated with these
serviced loans increased to a total of $2,285 as of June 30, 2002, compared to
an allowance of $30 as of June 30, 2001. Typically the impact of the changes in
the valuation allowance are offset by the gains realized on new residential real
estate production. The pipeline of loans in process in increasing due to the
lower rates, however the gains on the sale of these loans will not be realized
until the third and fourth quarter of 2002. The risk of further negative impacts
to earnings were partially reduced by the acquisition of $300 million in
notional value of interest rate floors. The floors are designed to bridge the
difference between the impact of lower rates on the value of the mortgage
servicing rights and the anticipated increase in gains on sale of residential
real estate loans.
12
(Dollars in thousands, except per share data)
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 the second quarter of 2002, personal trust accounts and employee
benefit accounts produced approximately 77% and 23% 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 7% from the second quarter of 2001 due the negative
impact of current market conditions on asset values. Our trust department had
approximately $595 million in assets under management at June 30, 2002 as
compared to $624 million at December 31, 2001.
Provision for loan losses. 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 was $1,303 for the second
quarter of 2002 versus $1,342 during the same period in 2001. Total net
charge-offs were $1,377 for the second quarter of 2002 versus $1,511 for the
second quarter of 2001. Loan losses are expected to remain slightly above their
historical level of .30% of gross loans for the remainder of the year, primarily
due to continued soft economic conditions and their impact on our commercial
borrowers. Consumer charge-offs are expected to be lower than the previous year
for the last two quarters of 2001 due to the improvement in the asset quality of
the consumer portfolio brought about by the de-emphasis on indirect automobile
lending.
Non-interest Income. Non-interest income (excluding security and trading gains
and losses) totaled $4,053 for the second quarter of 2002 versus $4,630 for the
same period last year. Excluding the impact of the changes in valuation
allowance for mortgage servicing rights of $1,375, non-interest income would
have totaled $5,428 for the second quarter of 2002, with the second quarter 2001
total for non-interest income remaining unchanged at $4,630. This improvement of
13.3% is primarily attributable to a 10.8% improvement in service charges on
deposit accounts (due to an increase in core transaction accounts) and a 54.5%
increase in the gain on sale of loans (due to increase residential real estate
loan sales associated with the lower interest rate environment).
Non-interest Expense. Expenses for the second quarter of 2002 were $11,283, up
15.14% from the same period last year due to the additional banking centers
acquired from Commerce and an increase in staff to manage the increased mortgage
banking activities. Salaries and employee benefits increased by 24.1% to $6,325
from the second quarter of 2001 while occupancy expense increased by 5.9% to
$1,125. Non-interest expenses declined from the linked quarter by $514, or 4.4%
due to the Company's continued focus on cost control.
Year-to-date Comparison
The Company reported net income of $9,036 for the first half of 2002. Net income
for the first half represented ninety cents ($.90) per share on a diluted basis.
Operating return on average assets (ROA) and return on average total
shareholders' equity (ROE) were 1.06% and 13.75%, respectively, for the first
half of 2002 compared to 1.08% and 14.03% for last year's first half. Net
interest income increased from $24,214 for the first half of 2001 to $28,560 for
this year's first half. The 17.9% improvement was primarily the result of an
improved net interest margin, which increased to 3.70% for the first half 2002
from 3.45% from the first half of 2001. The improvement also partially stemmed
from an 8.9% increase in average earning assets, primarily generated through the
Commerce acquisition. The efficiency ratio was slightly increased, from 58.36%
for the first half of 2001 to 59.47% for this year's first half. The increase in
valuation adjustments for mortgage servicing rights discussed in the quarterly
analysis was the primary reason for the increase.
13
(Dollars in thousands, except per share data)
Commercial Lending. Loan volume generated for the first half of 2002 totaled
$92.5 million versus $81.1 million for the same period in 2001. The portfolio
mix continues to shift towards more rate-sensitive and higher margin, variable
rate commercial loans.
Retail Lending. Indirect originations have decreased significantly from $42
million during the first half of 2001 to $27.7 million during the first half of
2002. Conversely, direct consumer lending has increased by 33% from $57.7
million for the first half of 2001 to $76.5 million for this year's first half.
Mortgage Banking. We originated $351 million in residential real estate loans
and sold approximately $336 million of loans during the first half of 2002,
generating a net gain of $2,860. Comparatively, we originated $200 million and
sold $115 million during the first half of 2001, generating net gains of $1,609.
Trust. During the first half of 2002, personal trust accounts and employee
benefit accounts produced approximately 75% and 25% of the total revenues of the
department, respectively. Fee income is down 7% from the second quarter of 2001
due the negative impact of current market conditions on asset values
Provision for Loan Losses. The provision for loan losses was $2,236 for the
second quarter of 2002 versus $2,103 during the same period in 2001. Total net
charge-offs were $2,121 for the second quarter of 2002 versus $1,711 for the
second quarter of 2001
Non-interest Income. Non-interest income (excluding security gains and losses
and trading activity) totaled $9,210 for the first half of 2002 versus $8,602
for the same period last year. Excluding the impact of the above mentioned
changes in valuation allowance for mortgage servicing rights, non-interest
income would have totaled $11,385 and $8,632 for the second quarters of 2002 and
2001, respectively. This improvement of 31.9% is primarily attributable to a
7..8% improvement in service charges on deposit accounts (due to an increase in
core transaction accounts) and a 72.2% increase in the gain on sale of loans
(due to increase residential real estate loan sales associated with the lower
interest rate environment).
Non-interest Expense. Expenses for the first half of 2002 were $23,080, up 16.2%
from the same period last year due to the additional banking centers acquired
from Commerce and an increase in staff to manage the increased mortgage banking
activities along with a $141 write-down in other real estate owned property.
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.
14
(Dollars in thousands, except per share data)
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 0.7% if interest
rates would immediately rise by 200 basis points. It projects an increase in net
income of 4.2% if interest rates would immediately fall by 175 basis points.
Management believes this reflects an acceptable level of risk from interest rate
movements based on the current level of interest rates. 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 bias
for the remainder of 2002. Management is in the process of shifting the
processing of the simulation modeling from in-house to a third party provider.
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.
15
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
(a) - (d) Second Bancorp Incorporated's Annual Meeting of Shareholders was held
on April 18, 2002. The results of the votes on the matters presented to
shareholders were included in the Form 10-Q for the period ended March 31, 2002.
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K:
The following exhibits are included herein:
Exhibit 11. Statement re: computation of earnings per share
Exhibit 99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Title 18, United States Code,
Section 1350, as Adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
The Company filed no reports on Form 8-K during the second quarter of 2002
except to announce quarterly earnings. The Company filed a report on Form 8-K on
April 22, 2002 to announce earnings for the first quarter of 2002. The Company
filed a report on Form 8-K on July 3, 2002 announcing an expected shortfall to
earnings versus consensus forecasts. The Company filed a report on Form 8-K on
July 19, 2002 to announce earnings for the second quarter 2002. The Company also
filed a report on Form 8-K on July 24, 2002 to announce authorization for an
additional discretionary 500,000 repurchase of the Company's common stock.
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: August 13, 2002 /s/ David L. Kellerman
--------------- -------------------------
David L. Kellerman, Treasurer
Signing on behalf of the registrant and as principal accounting officer and
principal financial officer.
17