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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
-------------
OR
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to _______________
Commission file Number 0-21720
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Slippery Rock Financial Corporation
(Exact Name of registrant as specified in its charter)
Pennsylvania 25-1674381
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
100 South Main Street
Slippery Rock, Pennsylvania 16057
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (724) 794-2210
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days. YES___X____ NO_______
As of August 1, 2002, there were 2,776,216 shares outstanding of the issuer's
class of common stock.
Slippery Rock Financial Corporation
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Part I Financial Information Page
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheet, June 30, 2002
and December 31, 2001 3
Consolidated Statements of Income
Six months ended June 30, 2002 and 2001 4
Consolidated Statement of Comprehensive Income
Six months ended June 30, 2002 and 2001 5
Consolidated Statement of Changes in
Stockholders' Equity, Six months ended
June 30, 2002 and 2001 6
Consolidated Statement of Cash Flows
Six months ended June 30, 2002 and 2001 7
Notes to Consolidated Financial Statements 8-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 16-17
Part II Other Information
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 19
Item 6. Exhibits and Reports of Form 8-K 19
Signatures 20
2
Slippery Rock Financial Corporation and Subsidiary
CONSOLIDATED BALANCE SHEET
(Unaudited - $ in 000)
June 30, December 31,
2002 2001
----------------- ------------------
ASSETS
Cash and due from banks $ 16,279 $ 14,903
Interest-bearing deposits in other banks 142 -
Federal funds sold 5,000 7,700
Mortgage loans held for sale 1,554 3,514
Investment securities:
Available for sale 60,321 44,217
Held to maturity (market value $2,907 and $1,129) 2,901 1,118
Loans 235,838 240,786
Less allowance for loan losses 3,123 2,766
----------------- ------------------
Net loans 232,715 238,020
Premises and equipment 7,363 7,518
Accrued interest and other assets 7,149 7,045
----------------- ------------------
Total assets $ 333,424 $ 324,035
================= ==================
LIABILITIES
Deposits:
Noninterest-bearing demand $ 45,244 $ 42,211
Interest-bearing demand 28,367 28,226
Savings 53,712 39,589
Money market 25,618 22,614
Time 117,743 129,255
----------------- ------------------
Total deposits 270,684 261,895
Other borrowings 30,219 30,260
Accrued interest and other liabilities 1,397 1,901
----------------- ------------------
Total liabilities 302,300 294,056
----------------- ------------------
STOCKHOLDERS' EQUITY
Common stock (par value $0.25; 12,000,000 shares authorized;
2,775,943 and 2,772,874 shares issued and outstanding) 694 693
Capital surplus 10,645 10,601
Retained earnings 19,244 18,731
Accumulated other comprehensive income (loss) 541 (46)
----------------- ------------------
Total stockholders' equity 31,124 29,979
----------------- ------------------
Total liabilities and stockholders' equity $ 333,424 $ 324,035
================= ==================
See accompanying notes to the unaudited consolidated financial statements
3
Slippery Rock Financial Corporation and Subsidiary
CONSOLIDATED STATEMENT OF INCOME
(Unaudited - $ in 000 except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
-------------------------- -------------------------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 4,462 $ 5,107 $ 9,080 $ 10,237
Federal funds sold 49 297 91 552
Interest and dividends on investment securities:
Taxable interest 451 142 859 283
Tax-exempt interest 160 200 326 397
Dividends 15 27 34 55
----------- ---------- ---------- ----------
Total interest and dividend income 5,137 5,773 10,390 11,524
INTEREST EXPENSE
Deposits 1,695 2,588 3,533 5,137
Other borrowings 391 393 778 834
----------- ---------- ---------- ----------
Total interest expense 2,086 2,981 4,311 5,971
----------- ---------- ---------- ----------
NET INTEREST INCOME 3,051 2,792 6,079 5,553
Provision for loan losses 306 105 611 210
----------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,745 2,687 5,468 5,343
OTHER INCOME
Service charges on deposit accounts 244 246 481 465
Trust department income 36 66 83 105
Net investment securities losses - - (7) -
Net gains on loan sales 218 59 243 194
Interchange fee income 70 67 132 116
Other income 115 191 235 328
----------- ---------- ---------- ----------
Total other income 683 629 1,167 1,208
OTHER EXPENSE
Salaries and employee benefits 1,153 1,013 2,397 2,047
Occupancy expense 168 157 345 317
Equipment expense 233 199 439 404
Data processing expense 89 84 176 161
Stationery, printing, and supplies 50 53 99 110
Pennsylvania shares tax 73 68 141 133
Other expense 603 480 1,153 966
----------- ---------- ---------- ----------
Total other expense 2,369 2,054 4,750 4,138
----------- ---------- ---------- ----------
Income before income taxes 1,059 1,262 1,885 2,413
Income tax expense 310 378 537 714
----------- ---------- ---------- ----------
NET INCOME $ 749 $ 884 $ 1,348 $ 1,699
=========== ========== ========== ==========
PER SHARE DATA
Average shares for the period, Basic 2,775,852 2,769,412 2,775,516 2,769,397
Average shares for the period, Diluted 2,776,015 2,769,412 2,775,516 2,769,397
Earnings per share, Basic $ 0.27 $ 0.32 $ 0.49 $ 0.61
Earnings per share, Diluted $ 0.27 $ 0.32 $ 0.49 $ 0.61
Dividends paid $ 0.15 $ 0.13 $ 0.30 $ 0.26
See accompanying notes to the unaudited consolidated financial statements
4
Slippery Rock Financial Corporation and Subsidiary
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited - $ in 000)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
------ ------ ------ ------
Net income $ 749 $ 884 $1,348 $1,699
Other comprehensive income:
Unrealized gains (losses) on available for sale securities 574 (111) 883 129
Reclassification adjustment for losses included in net income - - 7 -
------ ------ ------ ------
Other comprehensive income (loss) before tax 574 (111) 890 129
Income tax expense (benefit) related to other comprehensive income 195 (38) 303 44
------ ------ ------ ------
Other comprehensive income (loss), net of tax 379 (73) 587 85
------ ------ ------ ------
Comprehensive income $1,128 $ 811 $1,935 $1,784
====== ====== ====== ======
See accompanying notes to the unaudited consolidated financial statements
5
Slippery Rock Financial Corporation and Subsidiary
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited - $ in 000)
Accumulated
Other
Common Capital Retained Comprehensive
Stock Surplus Earnings Income(Loss) Total
--------------------------------------------------------------
Balance, December 31, 2001 $ 693 $ 10,601 $ 18,731 $ (46) $ 29,979
Net Income 1,348 1,348
Net unrealized gain on securities 587 587
Stock options exercised 1 44 (3) 42
Cash dividends ($0.30 per share) (832) (832)
--------------------------------------------------------------
Balance, June 30, 2002 $ 694 $ 10,645 $ 19,244 $ 541 $ 31,124
==============================================================
See accompanying notes to the unaudited consolidated financial statements
6
Slippery Rock Financial Corporation and Subsidiary
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited - $ in 000)
Six Months Ended
June 30,
2002 2001
-------- --------
OPERATING ACTIVITIES
Net income $ 1,348 $ 1,699
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 611 210
Depreciation, amortization and accretion of investment securities 409 398
Originations of mortgage loans held for sale (24,647) (9,097)
Proceeds from sales of mortgage loans 26,585 9,321
Net gains on loan sales (243) (194)
Net investment security losses 7 -
Decrease in accrued interest receivable 54 26
Increase (decrease) in accrued interest payable (454) 544
Other, net (208) (635)
-------- --------
Net cash provided by operating activities 3,462 2,272
-------- --------
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from sales 1,592 -
Proceeds from maturities and repayments 6,460 1,199
Purchases (23,295) (5,767)
Investment securities held to maturity:
Proceeds from maturities and repayments 216 507
Purchases (2,000) -
Decrease (Increase) in loans, net 4,673 (8,198)
Purchases of premises and equipment (246) (697)
-------- --------
Net cash used for investing activities (12,600) (12,956)
-------- --------
FINANCING ACTIVITIES
Increase in deposits, net 8,787 31,198
Decrease in short term borrowings - (30,000)
Proceeds from other borrowings - 30,000
Payments on other borrowings (41) (37)
Proceeds from stock options exercised 42 4
Cash dividends paid (832) (720)
-------- --------
Net cash provided by financing activities 7,956 30,445
-------- --------
Increase (decrease) in cash and cash equivalents (1,182) 19,761
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 22,603 12,642
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 21,421 $ 32,403
======== ========
Cash payments for interest $ 4,765 $ 5,427
Cash payments for income taxes $ 586 $ 725
See accompanying notes to the unaudited consolidated financial statements
7
Slippery Rock Financial Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and, therefore, do not
necessarily include all information, which would be included in audited
financial statements. The information furnished reflects all normal recurring
adjustments, which are, in the opinion of management, necessary for fair
statement of the results of the period. The results of operations for the
interim periods are not necessarily indicative of the results to be expected for
the full year.
NOTE 2 - RECLASSIFICATION OF COMPARATIVE AMOUNTS
Certain comparative amounts for the prior periods have been reclassified to
conform to current period presentations. Such reclassifications had no effect on
net income or stockholders' equity.
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS
In January 2002, the Company adopted FAS No. 142, Goodwill and Other Intangible
Assets, effective for fiscal years beginning after December 15, 2001. The
statement changes the accounting for goodwill from an amortization method to an
impairment-only approach. Thus, amortization of goodwill, including goodwill
recorded in past business combinations, will cease upon adoption of this
statement. However, this new statement did not amend FAS 72, Accounting for
Certain Acquisitions of Banking or Thrift Institutions, which requires
recognition and amortization of unidentified intangible assets relating to the
acquisition of financial institutions or branches thereof. The FASB has
undertaken a limited scope project to reconsider the provisions of FAS 72 in
2002 and has issued an exposure draft of a proposed statement, Acquisitions of
Certain Financial Institutions, that would remove acquisitions of financial
institutions from the scope of FAS No. 72. The adoption of this proposed
statement would require all goodwill originating from acquisitions that meet the
definition of a business combination as defined in Emerging Issues Task Force
Issue ("EITF") No. 98-3 to be discontinued. At June 30, 2002 the Company's
Consolidated Balance Sheet reflected total goodwill assets of $962,000 from
acquisitions currently accounted for under FAS No. 72. The Company has
determined that such assets meet the requirements of a business combination in
EITF No. 98-3. The adoption of this proposed statement and retroactive
application would subject such assets to the non-amortization provisions of FAS
No. 142 and would result in an increase in net income of $34,000, or $0.01 per
share, for the first half of 2002.
In August 2001, the FASB issued FAS No. 143, Accounting for Asset Retirement
Obligations, which requires that the fair value of a liability be recognized
when incurred for the retirement of a long-lived asset and the value of the
asset be increased by that amount. The statement also requires that the
liability be maintained at its present value in subsequent periods and outlines
certain disclosures for such obligations. The new statement takes effect for
fiscal years beginning after June 15, 2002. The adoption of this statement,
which is effective January 1, 2003, is not expected to have a material effect on
the Company's financial statements.
On January 1, 2002, the Company adopted FAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. FAS 144 supercedes FAS 121 and
applies to all long-lived assets (including discontinued operations) and
consequently amends APB Opinion No. 30, Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business. FAS 144
requires that long-lived assets that are to be disposed of by sale be measured
at the lower of book value or fair value less costs to sell. The adoption of FAS
No. 144 did not have a material effect on the Company's financial statements.
In April 2002, the FASB issued FAS No. 145, "Recission of FASB Statement No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections". FAS
No. 145 rescinds FAS No. 4, which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in Opinion 30 will now be used to classify those
8
gains and losses. This statement also amends FAS No. 13 to require that certain
lease modifications that have economic effects similar to sale-leaseback
transactions be accounted for in the same manner as sale-leaseback transactions.
This statement also makes technical corrections to existing pronouncements,
which are not substantive but in some cases may change accounting practice. FAS
No. 145 is effective for transactions occurring after May 15, 2002. The adoption
of FAS No. 145 did not have a material effect on the Company's financial
position or results of operations.
In July 2002, the FASB issued FAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. This statement replaces
EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred
in a Restructuring). The new statement will be effective for exit or disposal
activities initiated after December 31, 2002, the adoption of which is not
expected to have a material effect on the Company's financial statements.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Forward Looking Statement
The Private Securities Litigation Act of 1995 contains safe harbor provisions
regarding forward-looking statements. When used in this discussion, the words
"believes," "anticipates," "contemplates," "expects," and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from those projected. Those risks and uncertainties include changes
in interest rates, the ability to control costs and expenses, and general
economic conditions. The Company undertakes no obligation to publicly release
the results of any revisions to those forward-looking statements, which may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
Comparison of the Three Months Ended June 30, 2002 and 2001
Total interest income of $5,137,000 for the three-month period ended June 30,
2002 compared to $5,773,000 for the same three-month period in 2001, a decrease
of $636,000 or 11.0%. The overall decrease in total interest income is
attributed principally to a decrease in interest and fees on loans of $645,000
or 12.6%. Income from interest and fees on loans decreased due to a decrease in
yields within the loan portfolio. The tax equivalent yield on interest earning
assets fell from 8.19% at June 30, 2001 to 7.03% at June 30, 2002. As a result
of the Federal Reserve Board's action to manage interest rates in the U.S.
economy, interest rates were decreased eleven times in 2001. Prime rate, the
rate at which banks lend funds to their best commercial customers, was at 4.75%
at June 30, 2002. This is 2.25% lower than the prime rate of 7.00% at June 30,
2001. As interest rates fell, the Bank's variable rate earning assets repriced
downward, and continue to do so, while new loans with lower yields are being
added to the portfolio.
Although the tax equivalent yield on earning assets decreased during the
three-month period ended June 30, 2002, the average volume of loans increased.
Average gross loans, including loans available for sale, at June 30, 2002 were
$243.9 million, an increase of $6.3 million or 2.6% from $237.6 million at June
30, 2001. Virtually all major segments within the loan portfolio reflected net
increases in average balances from June 30, 2001. The most significant growth
occurred within the dealer and commercial segments. Average dealer loans
increased $2.6 million or 17.7% and average commercial loans increased $2.4
million or 11.2%. The increase within the average loan portfolio was brought
about by general market activity.
Total interest expense of $2,086,000 for the three-month period ended June 30,
2002 represented a decrease of $895,000 from the $2,981,000 reported for the
same three-month period in 2001. The change is comprised primarily of a decrease
in interest expense on deposits of $893,000. Although average interest-bearing
deposits increased $9.2 million, interest expense decreased for the period. This
resulted from a general decline in the Bank's cost of funds. The Bank's cost of
deposits decreased from 4.16% at June 30, 2001 to 2.86% at June 30, 2002. The
Bank also saw a shift in consumer preference within the interest bearing
deposits. Average time deposits decreased $11.6 million from June 30, 2001,
while the average savings products increased $16.2 million or 51.3%. Due to the
low interest rate environment, consumer preference has shifted towards the more
liquid products and away from the fixed maturity products.
Net interest income of $3,051,000 for the three months ended June 30, 2002
compared to $2,792,000 for the same three-month period in 2001, an increase of
$259,000.
The provision for loan losses for the three months ended June 30, 2002 was
$306,000, an increase of $201,000 from June 30, 2001. Management felt the
increase in the provision expense was warranted as a result of it's normal
quarterly analysis of loan loss reserve adequacy. The details of the analysis
and methodology are discussed further under the Risk Elements section that
follows.
Total other income for the three-month period ended June 30, 2002 of $683,000
compared to $629,000 for the
10
three-month period ended June 30, 2001, an increase of $54,000. An increase in
the gains on loan sales of $159,000 is partially offset by a decrease in other
income of $76,000 and trust income of $30,000.
Gains of $218,000 were recorded on the sale of $11.6 million of fixed rate, 1-4
family residential mortgages to the Federal Home Loan Mortgage Corporation
("Freddie Mac") for the three-month period ended June 30, 2002. For the
three-month period ended June 30, 2001, $5.5 million of fixed rated, 1-4 family
residential mortgages were sold resulting in a gain of $59,000.
Total other expense of $2,369,000 for the three months ended June 30, 2002
compared to $2,054,000 for the same three-month period in 2001. This represents
an increase of $315,000 or 15.3%. The increase is primarily derived from an
increase in salaries and employee benefits expense of $140,000 and an increase
in other expense of $123,000. The increases in salaries and employee benefits
resulted principally from additional staffing needs related to the new retail
facilities as well as an increase in the cost of employee benefits.
The recent growth of the Company caused slight increases in many areas that make
up other expense, such as legal and professional fees, collection expense, and
director and committee fees. These items were offset primarily by a decrease in
loan servicing fees. Loan servicing fees decreased due to a lower volume of
student loans being serviced by a third party.
Net income for the three-month period ended June 30, 2002 was $749,000, a
decrease of $135,000 from the $884,000 reported at June 30, 2001. Earnings per
share for the three-month period ended June 30, 2002 was $0.27, a decrease of
$0.05 from $0.32 per share earned during the same three-month period in 2001.
Comparison of the Six Months Ended June 30, 2002 and 2001
Total interest income of $10,390,000 for the six-month period ended June 30,
2002 compared to $11,524,000 for the same six-month period in 2001, a decrease
of $1,134,000 or 9.8%. The overall decrease in total interest income is
attributed principally to a decrease in interest and fees on loans of $1,157,000
or 11.3%. Income from interest and fees on loans decreased due to a decrease in
yields within the loan portfolio as discussed above.
Total interest expense of $4,311,000 for the six-month period ended June 30,
2002 represented a decrease of $1,660,000 from the $5,971,000 reported for the
same six-month period in 2001. The decrease in interest expense is comprised of
decreases in interest expense on deposits of $1,604,000 and on borrowed funds of
$56,000. The decrease in interest expense on both deposits and borrowed funds
was due to a general decline in the Bank's cost of funds.
Net interest income of $6,079,000 for the six months ended June 30, 2002
compared to $5,553,000 for the same six-month period in 2001, an increase of
$526,000.
The provision for loan losses for the six months ended June 30, 2002 was
$611,000, an increase of $401,000 from June 30, 2001. Management felt the
increase in the provision expense was warranted as a result of it's normal
quarterly analysis of loan loss reserve adequacy. The details of the analysis
and methodology are discussed further under the Risk Elements section that
follows.
Total other income for the six-month period ended June 30, 2002 of $1,167,000
compared to $1,208,000 for the six-month period ended June 30, 2001, a decrease
of $41,000. The decrease is primarily due to a decrease in other income of
$93,000 and trust department income of $22,000, which is partially offset by an
increase in the gains on loan sales of $49,000. Other income decreased primarily
due to a decrease in volume-based fees and to a decrease in insurance
commissions of $26,000.
Gains of $243,000 were recorded on the sale of $26.6 million of fixed rate, 1-4
family residential mortgages to the Federal Home Loan Mortgage Corporation
("Freddie Mac") for the six-month period ended June 30, 2002. For the six-month
period ended June 30, 2001, $9.3 million of fixed rated, 1-4 family residential
mortgages
11
were sold resulting in a gain of $194,000.
Total other expense of $4,750,000 for the six months ended June 30, 2002
compared to $4,138,000 for the same six-month period in 2001. This represents an
increase of $612,000 or 14.8%. The increase is primarily derived from an
increase in salaries and employee benefits expense of $350,000 and an increase
in other expense of $187,000. The increases in salaries and employee benefits
resulted principally from additional staffing needs related to the new retail
facilities as well as an increase in the cost of employee benefits.
The increase in other expense is primarily due to an increase in collection
expense of $57,000, legal and professional fees of $49,000, contributions
expense of $33,000, and director and committee fees of $32,000. Collection
expense increased due to increased legal costs associated with various
delinquency and foreclosure activities. Legal and professional fees increased
due to various projects that the Bank is currently involved in and are expected
to remain higher throughout the remainder of the year 2002. Contribution expense
has increased due to the Bank's contribution to a local community redevelopment
project. Director and Committee fees increased as a result of three additional
directors appointed in the third quarter of 2001. These increases were partially
offset by a decrease in loan servicing fees of $36,000. Loan servicing fees
decreased due to the lower volume of student loans being serviced by a third
party.
Net income for the six-month period ended June 30, 2002 was $1,348,000, a
decrease of $351,000 from the $1,699,000 reported at June 30, 2001. Earnings per
share for the six-month period ended June 30, 2002 was $0.49, a decrease of
$0.12 from $0.61 per share earned during the same six-month period in 2001.
Financial Condition
Total assets increased $9.4 million or 2.9% from $324.0 million at December 31,
2001 to $333.4 million at June 30, 2002. The increase in total assets is due to
an increase in available for sale investment securities of $16.1 million, the
majority of which are mortgage backed securities. Total gross loans (including
loans available for sale) decreased $6.9 million from December 31, 2001. The
most significant decrease within the loan portfolio occurred within the
residential real estate loans, which decreased $4.9 million. The sale of fixed
rate mortgages to the Federal Home Loan Mortgage Corporation was the major
contributor of this decrease. For the six months ended June 30, 2002, the
Company had sold $26.6 million of fixed rate mortgages, which compares to sales
of $25.2 million for the entire year of 2001. The increase in the volume of sold
loans can be attributed to an all time low in interest rates, which has resulted
in an increase in the demand for mortgage loans especially refinances.
Total deposits of $270.7 million at June 30, 2002 represented an increase of
$8.8 million or 3.4% from $261.9 million at December 31, 2001. With the
exception of time certificates, all deposit products had net increases during
the period. The most significant increase was within savings accounts, which
increased $14.1 million, followed by increases of $3.0 million in both
noninterest-bearing demand and money market accounts. With the recent decline in
the economy and interest rates, many customers are taking advantage of savings
products like the "Classic Plus Savings" product, which pays an attractive
market rate while fulfilling customer liquidity needs.
At June 30, 2002, the Company serviced approximately $77.1 million in sold fixed
rate mortgages. Sales of fixed rate mortgages for the six-month period ended
June 30, 2002 totaled $26.6 million with net gains of $243,000. Management does
anticipate future sales of fixed rate mortgages; however, the extent to which
the Company participates in the secondary market will be dependent upon demand
for fixed rate mortgages in the market place, liquidity needs of the Company and
interest rate risk exposure. Management will continue to obtain the necessary
documentation to allow loans to be sold in the secondary market, so that if
liquidity or market conditions dictate, management will be able to respond to
these conditions.
12
At June 30, 2002, management has calculated and monitored risk-based and
leverage capital ratios in order to assess compliance with regulatory
guidelines. The following schedule presents certain regulatory capital ratio
requirements along with the Company's position at June 30, 2002:
Actual Minimum Well
--------------------
Amount Ratio Ratio Capitalized
-------------------- -------- -------------
Tier 1 risk - based capital $29,388 13.55 % 4.00 % 6.00 %
Total risk - based capital 32,376 12.30 8.00 10.00
Leverage capital 29,388 8.97 4.00 5.00
As the above table illustrates, the Company exceeds both the minimum and
well-capitalized regulatory capital requirements at June 30, 2002. Management
does not anticipate any future activity that would have a negative impact on any
of these ratios. Also, management is not aware of any current recommendations by
the regulatory agencies that will have a material effect on future earnings,
liquidity or capital of the Company.
LIQUIDITY
The principal functions of the Company's asset/liability management program are
to provide adequate liquidity and to monitor interest rate sensitivity.
Liquidity represents the ability to meet the cash flow requirements of both
depositors and customers requesting bank credit. Asset liquidity is provided by
repayments and the management of maturity distributions for loans and
securities. An important aspect of asset liquidity lies in maintaining adequate
levels of adjustable rate, short term, or relatively risk free interest earning
assets. Management evaluates the Company's liquidity position over 30 day, 60
day, and 90+ day time horizons. The analysis not only identifies liquidity
within the balance sheet, but off balance sheet as well. It identifies
anticipated sources and uses of funds as well as potential sources and uses.
Anticipated needs would include liquidity for credit demand, commitments to
purchase assets, and anticipated deposit decreases. Anticipated sources would
include cash (net of reserve requirements), maturing investment securities,
daily fed funds sold, anticipated deposit increases, and the repayment of loans.
Potential uses would include unfunded loan commitments available on lines of
credit. Potential sources would include borrowing capacity available to the
Company through the FHLB. At June 30, 2002, for the 30-day horizon, the Company
had a net anticipated funding position of 0.5% of total assets. This ratio was
3.5% as of December 31, 2001. Management views this ratio to be at an adequate
level.
Management also monitors its liquidity by the loans to deposits ratio. The loans
(including loans held for sale) to deposits ratio was 87.7% at June 30, 2002 as
compared to 93.2% at December 31, 2001 and 93.6% at June 30, 2001.
The Company's liquidity plan allows for the use of long-term advances or
short-term lines of credit with the Federal Home Loan Bank ("FHLB") as a source
of funds. Borrowing from the FHLB not only provides a source of liquidity for
the Company, but also serves as a tool to reduce interest rate risk. The Company
may structure borrowings from FHLB to match those of customer credit requests,
and therefore, lock in interest rate spreads over the lives of the loans. At
June 30, 2002, the Company continued to have three such matched funding loans
outstanding totaling $148,000.
The Company continues to also have short-term borrowing availability through
FHLB "RepoPlus" advances. "RepoPlus" advances are short-term borrowings maturing
within one year, bearing a fixed rate of interest and subject to prepayment
penalty. At June 30, 2002 and 2001, the Company had no "RepoPlus" advances
outstanding. The Company's remaining borrowing capacity with FHLB was $76.9
million at June 30, 2002.
In addition to borrowing from the FHLB as a source for liquidity, as mentioned
earlier, the Company also
13
continued activity in the secondary mortgage market. Specifically, the Company
sold fixed rate residential real estate mortgages to Freddie Mac. The sales to
Freddie Mac not only provide an opportunity for the Company to remain
competitive in the market place by allowing it to offer a fixed rate mortgage
product, but also provide an additional source of liquidity. Loan sales on the
secondary market also provide management an additional tool to use in managing
interest rate risk exposure within the balance sheet. The Company continues to
service all loans sold to Freddie Mac.
The Statement of Cash Flows, for the six-month period ended June 30, 2002,
indicates a decrease in cash and cash equivalents of $1.2 million. Cash was
provided from proceeds from sales of mortgage loans of $26.6 million, proceeds
from sales, maturities, and repayments of available for sale and held to
maturity securities of $8.3 million, and a net increase in deposits of $8.8
million. Cash was used during the period for the origination of loans held for
sale of $24.6 million, the purchase of available for sale investments of $23.3
million, and the purchase of held to maturity investment of $2.0 million. Cash
dividends paid during the six-month period ended June 30, 2002 totaled $832,000.
Cash and cash equivalents totaled $21.4 million at June 30, 2002, a decrease of
$1.2 million from $22.6 million at December 31, 2001.
Management is not aware of any conditions, including any regulatory
recommendations or requirements, which would adversely affect its liquidity or
ability to meet its funding needs in the normal course of business.
RISK ELEMENTS
The following schedule presents the non-performing assets for the last five
quarters:
Jun Mar Dec Sept Jun
2002 2002 2001 2001 2001
------ ------ ------ ------ ------
(dollars in thousands)
Non-performing and restructured loans
Loans past due 90 days or more $ 52 $ 27 $ 69 $ 49 $ 32
Non-accrual loans 3,547 3,862 3,958 2,640 2,621
Restructured loans 463 - - - -
------ ------ ------ ------ ------
Total non-performing
and restructured loans 4,062 3,889 4,027 2,689 2,653
------ ------ ------ ------ ------
Other non-performing assets
Other real estate owned 251 335 216 193 -
Repossessed assets 94 37 22 46 77
------ ------ ------ ------ ------
Total other non-performing assets 345 372 238 239 77
------ ------ ------ ------ ------
Total non-performing assets $4,407 $4,261 $4,265 $2,928 $2,730
====== ====== ====== ====== ======
Non-performing and restructured loans
as a percentage of total loans(1) 1.72 % 1.60 % 1.67 % 1.12 % 1.11 %
Non-performing assets and
restructured loans as a
percentage of total loans
and other non-performing
Assets and restructured loans(1) 1.87 % 1.76 % 1.77 % 1.22 % 1.14 %
(1) Excludes loans held for sale.
14
The allowance for loan losses at June 30, 2002 totaled $3,123,000 or 1.32% of
total loans (including loans held for sale) as compared to $2,766,000 or 1.13%
at December 31, 2001. Provisions for loan losses were $611,000 and $210,000 for
the six-month periods ended June 30, 2002 and 2001. Based on the Bank's
methodology for evaluating the level of the loan loss allowance, growth in the
loan portfolio over the past two years, and the uncertainties in the current
economic and financial markets; management felt it prudent to further bolster
the allowance in 2002. This action not only enhances financial strength and
stability in the current environment, but for subsequent periods as well.
In determining the level at which the allowance for loan losses should be
maintained, management relies on in-house quarterly reviews of significant loans
and commitments outstanding, including a continuing review of problem or
non-performing loans and overall portfolio quality. Commercial and commercial
real estate loans are risk-rated by individual loan officers and a loan review
committee. Consumer and residential real estate loans are generally reviewed in
the aggregate due to their relative smaller dollar size and homogeneous nature.
Specific provision and allowance allocations are made for risk-rated loans that
have gone before the loan review committee. These allocations are based upon
specific borrower data, such as non-performance, delinquency, financial
performance, capacity to repay, and collateral valuation. Non-account specific
allocations are made for all remaining loans within the portfolio based on
recent charge-off history, other known trends and expected losses. In addition,
allocations are made for qualitative factors such as changes in the local,
regional and national economies, industry trends, loan growth, and loan
administration. A quarterly report and recommendation is presented to and
approved by the Board of Directors. Management believes the allowance is
adequate to cover known losses within the loan portfolio. However, no assurances
can be made concerning the future financial condition of borrowers, the
deterioration of which would require additional provisions in subsequent
periods.
A loan is considered impaired when, based upon current information and events,
it is probable that the Company will be unable to collect all principal and
interest amounts due according to the contractual terms of the loan agreement.
At June 30, 2002, the Company had nonaccrual loans of $3,547,000. Impaired loans
at June 30, 2002 were $3,758,000, of which, $3,295,000 were also classified as
nonaccrual. The average balance in 2002 of impaired loans was $3,669,000.
Impaired loans had a related allowance allocation of $652,000 and income
recognized in 2002 for impaired loans totaled $78,000.
Impaired loans at June 30, 2002 were comprised principally of two borrowers.
These borrowers accounted for $2.4 million of total impaired loans. One credit,
totaling $1.6 million, was classified as impaired during the fourth quarter of
2001 as a result of the borrower's deteriorating financial condition. The
Company recently received this borrower's bankruptcy notification.
The second largest borrower within the impaired loan accounts, with a balance of
$801,000, pertains to a participated loan for a dairy operation. The Company was
cross-collateralized on cattle, feed, and real estate, including facilities. In
1999, the Bank recorded a $300,000 charge off pertaining to the cattle portion
of the loan. The borrower has subsequently filed for bankruptcy relief, and the
Company continues foreclosure proceedings on the real estate portion of the loan
through the bankruptcy courts. An additional $100,000 charge off was recorded in
2000. As a result of prudent collateral valuation, the Company recorded an
additional $190,000 charge off in the fourth quarter of 2001. Management will
continue its collateral valuations until final resolution of the matter which
may result in additional chargeoffs. Although the Company originally anticipated
possession of the real estate in 2001, it now appears that possession will occur
in the fourth quarter of 2002.
Management does not consider any of the remaining non-performing loans to pose
any significant risk to the capital position or future earnings of the Company.
Management believes none of the non-performing assets, including other real
estate owned, at June 30, 2002, pose any significant risk to the operations,
liquidity or capital position of the Company.
15
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk for the Company is comprised primarily from interest rate risk
exposure and liquidity risk. Since virtually all of the interest-earning assets
and paying liabilities are at the Bank, virtually all of the interest rate risk
and liquidity risk lies at the Bank level. The Bank is not subject to currency
exchange risk or commodity price risk, and has no trading portfolio, and
therefore, is not subject to any trading risk. In addition, the Bank does not
participate in hedging transactions such as interest rate swaps and caps.
Changes in interest rates will impact both income and expense recorded and also
the market value of long-term interest-earning assets. Interest rate risk and
liquidity risk management is performed at the Bank level. Although the Bank has
a diversified loan portfolio, loans outstanding to individuals and businesses
are dependent upon the local economic conditions in the immediate trade area.
One of the principal functions of the Company's asset/liability management
program is to monitor the level to which the balance sheet is subject to
interest rate risk. The goal of the asset/liability program is to manage the
relationship between interest rate sensitive assets and liabilities, thereby
minimizing the fluctuations in the net interest margin, which achieves
consistent growth of net interest income during periods of changing interest
rates.
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of a bank's rate sensitive assets and rate sensitive
liabilities. These differences, or interest rate repricing "gap", provide an
indication of the extent that the Company's net interest income is affected by
future changes in interest rates. During a period of rising interest rates, a
positive gap, a position of more rate sensitive assets than rate sensitive
liabilities, is desired. During a falling interest rate environment, a negative
gap is desired, that is, a position in which rate sensitive liabilities exceed
rate sensitive assets.
At June 30, 2002, the Company had a cumulative negative gap of $44.1 million at
the one-year horizon. The gap analysis indicates that if interest rates were to
rise 100 basis points (1.00%), the Company's net interest income would decline
at the one-year horizon because the Company's rate sensitive liabilities would
reprice faster than rate sensitive assets. Conversely, if rates were to fall 100
basis points, the Company would earn more in net interest income.
Management also manages interest rate risk with the use of simulation modeling
which measures the sensitivity of future net interest income as a result of
changes in interest rates. The analysis is based on repricing opportunities for
variable rate assets and liabilities and upon contractual maturities of fixed
rate instruments.
The simulation also calculates net interest income based upon rate increases or
decreases of + or- 300 basis points (or 3.00%) in 100 basis point (or 1.00%)
increments. The analysis reprices the balance sheet and forecasts future cash
flows over a one-year horizon at the new interest rate levels. The cash flows
are then totaled to calculate net interest income. Assumptions are made for loan
and investment pre-payment speeds and are incorporated into the simulation as
well. Loan and investment pre-payment speeds will increase as interest rates
decrease and slow as interest rates rise. The current analysis indicates that,
given a 300 basis point overnight decrease in interest rates, the Company would
experience a potential $2,293,000 or 17.9% decline in net interest income. If
rates were to increase 300 basis points, the analysis indicates that the
Company's net interest income would increase $813,000 or 6.3%. It is important
to note, however, that this exercise would be of a worst-case scenario. It would
be more likely to have incremental changes in interest rates, rather than a
single significant increase or decrease. When management believes interest rate
movements will occur, it can restructure the balance sheet and thereby the ratio
of rate sensitive assets to rate sensitive liabilities which in turn will effect
the net interest income. It is important to note; however, not all assets and
liabilities with similar maturities and repricing opportunities will reprice at
the same time or to the same degree and therefore, could effect forecasted
results.
Much of the Bank's deposits have the ability to reprice immediately; however,
deposit rates are not tied to an external index. As a result, although changing
market interest rates impact repricing, the Bank retains much of
16
the control over repricing by determining itself the extent and timing of
repricing of deposit products. In addition, the Bank maintains a significant
portion of its investment portfolio as available for sale securities and also
has a significant variable rate loan portfolio, which is used to offset rate
sensitive liabilities.
Changes in market interest rates can also affect the Bank's liquidity position
through the impact rate changes may have on the market value of the available
for sale portion of the investment portfolio. Increases in market rates can
adversely impact the market values and therefore, make it more difficult for the
Bank to sell available for sale securities needed for general liquidity purposes
without incurring a loss on the sale. This issue is addressed by the Bank with
the use of borrowings from the Federal Home Loan Bank ("FHLB") and the selling
of fixed rate mortgages as a source of liquidity to the Bank.
The Company's liquidity plan allows for the use of long-term advances or
short-term lines of credit with the FHLB as a source of funds. Borrowing from
FHLB not only provides a source of liquidity for the Company, but also serves as
a tool to reduce interest risk as well. The Company may structure borrowings
from FHLB to match those of customer credit requests, and therefore, lock in
interest rate spreads over the lives of the loans.
In addition to borrowing from the FHLB as a source for liquidity, the Company
also participates in the secondary mortgage market. Specifically, the Company
sells fixed rate, residential real estate mortgages to the Federal Home Loan
Mortgage Corporation ("Freddie Mac"). The sales to Freddie Mac not only provide
an opportunity for the Bank to remain competitive in the market place, by
allowing it to offer a fixed rate mortgage product, but also provide an
additional source of liquidity and an additional tool for management to limit
interest rate risk exposure. The Bank continues to service all loans sold to
Freddie Mac.
17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
(none)
Item 2. Changes in Securities and Use of Proceeds
(none)
Item 3. Defaults Upon Senior Securities
(none)
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders of Slippery Rock Financial Corporation took
place on April 16, 2002. The following two (2) matters were voted upon:
(1) Election of the four (4) persons listed in CLASS I of the Proxy Statement
dated March 29, 2002 whose terms expire in 2005.
CLASS I Directors:
------------------
Mr. John W. Conway
Mr. William D. Kingery
Mr. Scott A. McDowell
Mr. Charles C. Stoops, Jr.
(2) Such other business as may properly come before the meeting or any
adjournment thereof.
Continuing CLASS II directors whose terms expire in 2003 are:
Mr. Robert M. Greenberger
Ms. Brenda K. McBride
Mr. William C. Sonntag
Mr. Norman P. Sundell
Continuing CLASS III directors whose terms expire in 2004 are:
Mr. Grady W. Cooper
Mr. Robert E. Gregg
Mr. Thomas D. McClymonds
Mr. S.P. Snyder
Mr. Kenneth D. Wimer
The following table presents the results of the vote tabulation
Issue Description Votes For Votes Against
1 Election of CLASS I Directors
Mr. John W. Conway 2,116,239 200
Mr. William D. Kingery 2,116,239 200
Mr. Scott A. McDowell 2,102,769 13,670
Mr. Charles C. Stoops, Jr. 2,116,439 -
2 No other issues were brought before the meeting.
18
Item 5. Other Information
(none)
Item 6. Exhibits and Reports on Form 8 - K
(a) Exhibits required by Item 601 of Regulation S - K:
Exhibit Number
2 N/A
3(i) Articles of Incorporation filed on March 6, 1992 as Exhibit 3(i)
to Registration Statement on Form S-4 (No. 33-46164) and
incorporated herein by reference.
3(ii) By - laws filed on March 6, 1992 as Exhibit 3(ii) to
Registration Statement on Form S-4 (No.33-46164) and
incorporated herein by reference.
4 N/A
10 N/A
11 N/A
15 N/A
18 N/A
19 N/A
22 N/A
23 N/A
24 N/A
99.0 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Independent Auditor's Review
(b) Reports on Form 8-K
None
19
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.
Slippery Rock Financial Corporation
(Registrant)
Date: August 7, 2002 By:/s/ William C. Sonntag
-------------------- ----------------------
William C. Sonntag
President & CEO
Date: August 7, 2002 By: /s/ Mark A. Volponi
-------------------- --------------------
Mark A. Volponi
Treasurer
20