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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
------------------
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF
1934 for the quarterly period ended September 30, 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
SECOND BANCORP INCORPORATED
(exact name of registrant as specified in its charter)
Ohio 34-1547453
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
108 Main Ave. S. W. Warren, Ohio 44482-1311
(Address of principal executive offices) (Zip Code)
330.841.0123
Registrant's telephone number, including area code
Not applicable
Former name, former address and former fiscal year,
if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, without par value - 9,861,854 shares outstanding as of October 31,
2002.
SECOND BANCORP INCORPORATED AND SUBSIDIARIES
INDEX
Page
Number
------
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated balance sheets -
September 30, 2002 and 2001 and December 31, 2001 3
Consolidated statements of income -
Three and nine months ended September 30, 2002 and 2001. 4
Consolidated statements of comprehensive income -
Three and nine months ended September 30, 2002 and 2001 5
Consolidated statements of shareholders' equity -
Nine months ended September 30, 2002 and 2001 6
Consolidated statements of cash flows -
Nine months ended September 30, 2002 and 2001 7-8
Notes to consolidated financial statements - September 30, 2002 9-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 17
Item 4. Controls and Procedures 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20-21
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
September 30 December 31 September 30
(Dollars in thousands) 2002 2001 2001
- ---------------------- ---- ---- ----
ASSETS
Cash and due from banks $ 40,815 $ 40,837 $ 32,441
Federal funds sold and temporary investments 15,033 24,016 51,233
Securities:
Available-for-sale (at market value) 535,174 417,496 407,004
----------- ----------- -----------
Total securities 535,174 417,496 407,004
Loans 1,153,581 1,121,892 1,060,778
Less reserve for loan losses 17,443 16,695 15,429
----------- ----------- -----------
Net loans 1,136,138 1,105,197 1,045,349
Premises and equipment 16,333 16,416 16,650
Accrued interest receivable 9,582 10,272 10,272
Goodwill and intangible assets 31,185 26,578 8,328
Other assets 40,975 39,544 37,742
----------- ----------- -----------
Total assets $ 1,825,235 $ 1,680,356 $ 1,609,019
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Demand - non-interest bearing $ 153,341 $ 144,953 $ 111,539
Demand - interest bearing 98,359 105,221 94,831
Savings 410,322 276,628 234,601
Time deposits 519,259 596,329 616,320
----------- ----------- -----------
Total deposits 1,181,281 1,123,131 1,057,291
Federal funds purchased and securities sold under
agreements to repurchase 166,532 107,279 110,071
Note payable 3,000 0 0
Other borrowed funds 3,788 5,853 5,745
Federal Home Loan Bank advances 285,887 275,152 267,301
Accrued expenses and other liabilities 14,583 10,200 11,185
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust 30,482 30,442 26,660
----------- ----------- -----------
Total liabilities 1,685,553 1,552,057 1,478,253
Shareholders' equity:
Common stock, no par value; 30,000,000 shares
authorized; 11,024,693,10,832,810 and 10,828,310
shares issued, respectively 40,994 37,453 37,424
Treasury stock; 1,147,849, 883,494 and 801,512
shares, respectively (23,631) (16,798) (15,072)
Other comprehensive income 8,894 3,434 6,850
Retained earnings 113,425 104,210 101,564
----------- ----------- -----------
Total shareholders' equity 139,682 128,299 130,766
----------- ----------- -----------
Total liabilities and shareholders' equity $ 1,825,235 $ 1,680,356 $ 1,609,019
=========== =========== ===========
See notes to consolidated financial statements.
3
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Income
For the Three Months For the Nine Months
(Dollars in thousands, Ended September 30 Ended September 30
------------------ ------------------
except per share data) 2002 2001 2002 2001
---- ---- ---- ----
INTEREST INCOME
Loans (including fees):
Taxable $ 19,598 $ 21,015 $ 60,034 $ 64,867
Exempt from federal income taxes 227 268 703 835
Securities:
Taxable 5,963 5,471 17,082 15,898
Exempt from federal income taxes 722 800 2,211 2,348
Federal funds sold and other 324 326 931 815
---------- ------------ ------------ ------------
Total interest income 26,834 27,880 80,961 84,763
INTEREST EXPENSE
Deposits 7,526 10,467 22,629 33,128
Federal funds purchased and securities
sold under agreements to repurchase 597 937 1,799 3,177
Note Payable 10 13 10 47
Other borrowed funds 10 23 28 75
Federal Home Loan Bank advances 4,003 3,946 11,781 11,628
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust 734 21 2,200 21
---------- ------------ ------------ ------------
Total interest expense 12,880 15,407 38,447 48,076
---------- ------------ ------------ ------------
Net interest income 13,954 12,473 42,514 36,687
Provision for loan losses 1,573 988 3,809 3,091
---------- ------------ ------------ ------------
Net interest income after provision for loan losses 12,381 11,485 38,705 33,596
NON-INTEREST INCOME
Service charges on deposit accounts 1,505 1,344 4,236 3,878
Trust fees 596 761 2,078 2,266
Gain on sale of loans 2,421 1,394 5,674 3,283
Trading account (losses) gains 0 (52) (20) 19
Security gains 832 123 659 640
Other operating income 1,807 921 3,551 3,595
---------- ------------ ------------ ------------
Total non-interest income 7,161 4,491 16,178 13,681
NON-INTEREST EXPENSE
Salaries and employee benefits 6,494 5,313 19,128 15,603
Net occupancy 1,119 1,001 3,381 3,179
Equipment 931 1,038 3,156 3,008
Professional services 563 320 1,491 1,060
Assessment on deposits and other taxes 384 415 1,043 1,221
Amortization of goodwill and other intangibles 110 81 331 242
Merger costs 124 0 124 0
Other operating expenses 2,116 1,914 6,267 5,625
---------- ------------ ------------ ------------
Total non-interest expense 11,841 10,082 34,921 29,938
---------- ------------ ------------ ------------
Income before federal income taxes 7,701 5,894 19,962 17,339
Income tax expense 2,165 1,493 5,390 4,492
---------- ------------ ------------ ------------
Net income before cumulative effect of
accounting change $ 5,536 $ 4,401 $ 14,572 $ 12,847
========== ============ ============ ============
Cumulative effect of accounting change - SFAS133 0 0 0 (101)
---------- ------------ ------------ ------------
Net income $ 5,536 $ 4,401 $ 14,572 $ 12,746
========== ============ ============ ============
NET INCOME PER COMMON SHARE:
Basic - before cumulative effect
of accounting change n/a n/a n/a $ 1.28
Diluted - before cumulative effect
of accounting change n/a n/a n/a $ 1.27
Basic $ 0.56 $ 0.44 $ 1.47 $ 1.27
Diluted $ 0.55 $ 0.43 $ 1.45 $ 1.26
Weighted average common shares outstanding:
Basic 9,876,844 10,033,365 9,929,276 10,021,471
Diluted 9,993,241 10,117,705 10,051,077 10,087,935
See notes to consolidated financial statements.
4
Second Bancorp Incorporated and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Three Months For the Nine Months
(Dollars in thousands, Ended September 30 Ended September 30
------------------ ------------------
except per share data) 2002 2001 2002 2001
---- ---- ---- ----
Net income $ 5,536 $ 4,401 $ 14,572 $ 12,746
Other comprehensive income, net of tax:
Change in other comprehensive income - deferred
compensation plan (41) 12 (41) (59)
Change in unrealized market value adjustment
on securities available-for-sale 1,670 5,028 5,501 6,628
------- ------- -------- --------
Total other comprehensive income 1,629 5,040 5,460 6,569
------- ------- -------- --------
Comprehensive income $ 7,165 $ 9,441 $ 20,032 $ 19,315
======= ======= ======== ========
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 12,746 12,746
Change in other comprehensive income - deferred
compensation plan, net of tax of $(31) (59) (59)
Change in unrealized market value adjustment
on securities available-for-sale, net of
tax of $3,573 6,628 6,628
Cash dividends declared: common ($.51 per share) (5,110) (5,110)
Purchase of treasury shares (1,125) (1,125)
Common stock issued -
stock options and dividend reinvestment plan 489 489
-------- -------- ------ -------- --------
Balance, September 30, 2001 $ 37,424 $(15,072) $6,850 $101,564 $130,766
======== ======== ====== ======== ========
Balance, January 1, 2002 $ 37,453 $(16,798) $3,434 $104,210 $128,299
Net income 14,572 14,572
Change in other comprehensive income - deferred
compensation plan, net of tax of $(22) (41) (41)
Change in unrealized market value adjustment
on securities available-for-sale, net of
tax of $2,962 5,501 5,501
Cash dividends declared: common ($.54 per share) (5,357) (5,357)
Purchase of treasury shares (6,833) (6,833)
Common stock issued - dividend reinvestment plan 3,541 3,541
-------- -------- ------ -------- --------
Balance, September 30, 2002 $ 40,994 $(23,631) 8,894 $113,425 $139,682
======== ======== ====== ======== ========
See notes to consolidated financial statements.
6
Second Bancorp Incorporated and Subsidiaries (Dollars in thousands,
Consolidated Statements of Cash Flows except per share data)
For the Nine Months Ended
-------------------------
September September
(Dollars in thousands) 2002 2001
---- ----
OPERATING ACTIVITIES
Net income $ 14,572 $ 12,746
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 3,809 3,091
Provision for depreciation 2,602 2,556
Provision for amortization of intangibles 331 242
Amortization of servicing rights 2,212 (2,532)
Accretion of investment discount and premium (253) (316)
Amortization of underwriting costs - corporation-obligated
mandatorily redeemable capital securities of subsidiary trust 40 0
Increase in allowance for servicing rights 2,277 0
Deferred income taxes 1,561 (338)
Securities gains (659) (640)
Other gains, net (4,391) (3,279)
Net decrease in trading account securities 0 328
Decrease in interest receivable 690 909
Decrease in interest payable (395) (542)
Originations of loans held-for-sale (505,050) (295,166)
Proceeds from sale of loans held-for-sale 509,439 298,449
Net change in other assets & other liabilities (1,716) 992
--------- ---------
Net cash provided by operating activities 24,996 16,500
INVESTING ACTIVITIES
Proceeds from maturities of securities - available-for-sale 138,279 93,400
Proceeds from sales of securities - available-for-sale 174,052 76,420
Purchases of securities - available-for-sale (420,670) (183,575)
Net (increase) decrease in loans (41,590) 6,432
Net increase in premises and equipment (2,517) (1,171)
--------- ---------
Net cash provided by investing activities (152,446) (8,494)
FINANCING ACTIVITIES
Net increase (decrease) demand deposits, interest bearing demand and savings
deposits 135,220 (2,398)
Net (decrease) increase in time deposits (77,070) 23,554
Net increase (decrease) in federal funds purchased
and securities sold under agreements to repurchase 59,253 (19,824)
Increase (decrease) in note payable 3,000 (1,000)
Net (decrease) increase in borrowings (2,065) 3,582
Net advances from Federal Home Loan Bank 10,735 15,568
Issuance of corporation-obligated mandatorily redeemable
capital securities of subsidiary trust 0 26,660
Cash dividends (5,357) (5,110)
Purchase of treasury stock (6,833) (1,125)
Net issuance of common stock 1,562 489
--------- ---------
Net cash provided by financing activities 118,445 40,396
--------- ---------
Increase in cash and cash equivalents (9,005) 48,402
--------- ---------
Cash and cash equivalents at beginning of year 64,853 35,272
--------- ---------
Cash and cash equivalents at end of period $ 55,848 $ 83,674
========= =========
7
Supplementary Cash Flow Information:
Cash paid for 1) Federal income taxes - $5,390,000 and $3,850,000 for the nine
months ended September 30, 2002, and 2001, respectively and 2) Interest -
$35,859,000 and $48,618,000 for the nine months ended September 30, 2002 and
2001, respectively.
See Notes to Consolidated Financial Statements
8
Second Bancorp Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (unaudited) September 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 nine-month periods ended September 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 nine months of 2002 and 2001, total comprehensive income
amounted to $20,032 and $19,315, respectively. The components of comprehensive
income, net of tax, for the nine-month periods ended September 30, 2002 and 2001
are as follows:
2002 2001
-------- --------
Net income $ 14,572 $ 12,746
Change in other comprehensive income -
deferred compensation plan (41) (59)
Unrealized gains on available-for-sale securities 5,501 6,628
-------- --------
Comprehensive income $ 20,032 $ 19,315
======== ========
Accumulated other comprehensive income, net of related tax, at September 30,
2002, December 31, 2001 and September 30, 2001 totaled $8,894, $3,434 and
$6,850, 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:
Nine Months Ended
---------------------------------
Sept. 30, 2002 Sept. 30, 2001
-------------- --------------
Unrealized holding gains arising during the period $ 5,929 $ 7,044
Less: reclassification of gains included in net income (428) (416)
------- -------
Net unrealized gains on available-for-sale securities $ 5,501 $ 6,628
======= =======
9
(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 $140 for the first nine
months of 2001 and $187 for the year 2001. Application of the non-amortization
provisions of the statement increased net income by $91 or $.01 per share in the
first nine months 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 nine months ended September 30, 2001 was
$4,401 and $12,746. Adjusting for the amortization provisions of SFAS No. 142,
net income for the three and nine months ended September 30, 2001 would have
been $4,431 and $12,837, respectively. Basic and diluted earnings per share
would have been $0.44 and $0.44 for the three months ended September 30, 2001,
respectively and $1.28 and $1.27 for the nine months ended September 30, 2001,
respectively.
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 3,809 3,091
Charge-offs 4,026 4,013
Recoveries 965 1,134
------- -------
Net charge-offs 3,061 2,879
------- -------
Ending balance, September 30 $17,443 $15,429
======= =======
As a percentage of loans 1.51% 1.45%
10
(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 36
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 two other subsidiaries,
Stouffer-Herzog Insurance Agency, Inc. ("Stouffer-Herzog") and Second Bancorp
Capital Trust I. Stouffer-Herzog was acquired in the third quarter of 2002 and
operates primarily in northeast Ohio selling a wide-range of personal and
commercial property & casualty and life & health products. Second Bancorp
Capital Trust I was established in 2001 to facilitate raising Tier I eligible
capital in the form of corporation-obligated mandatorily 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 September 30, 2002, the Company had consolidated total assets of $1.82
billion, deposits of $1.18 billion and shareholders' equity of $140 million.
Since September 30, 2001, total assets have increased by $216 million or 13.4%,
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 $93 million during the
past year, the same amount was acquired from Commerce. Real estate loans
declined by $9 million since September 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 September 30, 2001 to a 45%, 28%, 27% mix at the end
of the most recent quarter. Approximately $12 million of loans previously
classified as consumer loans were reclassified as commercial loans during the
third quarter as they are revolving lines to business customers.
Deposits increased by $124 million since September 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 $97 million from a year ago. Savings
accounts have increased by $175 million primarily as 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 $42
million over the same time period. The growth is evenly split between balances
acquired from Commerce and internal growth. The corporation-obligated
mandatorily redeemable capital securities of subsidiary trust (the "Trust
Preferred Securities") used to finance the Commerce acquisition totaled $30.5
million as of September 30, 2002.
11
(Dollars in thousands, except per share data)
Since June 30, 2002, total assets have increased by $104 million. Commercial
lending activities have increased, especially in the western-most counties.
Commercial loan balances increased by $34 million ($12 million as a result of
balances transferred from the consumer loan category). Strong secondary mortgage
activities have kept real estate balances at below 30% of total loans, despite
the record level of loan originations. The internal shift away from both
indirect automobile lending has kept internal consumer 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 $35 million
during the most recent quarter, with savings accounts, time deposits and demand
deposits increasing by $15 million, $12 million and $8 million, respectively.
Asset Quality. The level of non-performing loans increased significantly during
the quarter and totaled $20,010 as of September 30, 2002. This represents an
increase of $7,515 from the previous quarter end due primarily to the inclusion
of two related credits totaling $7.3 million with lease receivables as
collateral. The company that originated the leases has declared bankruptcy and
has allegedly perpetrated fraud in the creation of some of the leases. The
leases were supported by surety bonds from two well-capitalized insurance
companies. Due in part to the nationwide scope of the issue and the alleged
fraud, the insurance companies have thus far refused payment. The Company is
currently litigating the matter and investigating the actual validity of the
leases supporting the two loans. Due in part to the first interest in the $11
million in collateral (lease obligations) that supports loans and the contention
that the insurance companies are still obligated to uphold their surety, the
Company continues to maintain the loans as non-performing loans with a specific
reserve assigned to the credits. As the additional investigation continues as to
the validity of the individual leases, that specific reserve amount may be
adjusted.
Non-accrual loans have increased to $12,756 over the past year from $4,273 as of
September 30, 2001 and represent not only the two credits detailed previously,
but also an increase in delinquencies among smaller commercial credits due to
the general weakness of the economy. Loans past due over 90 days and still
accruing totaled $6,955 as of September 30, 2002, up 49% from September 30,
2001, reflecting the general economic slowdown in both the national and local
economies. Approximately 46% of the loans past due over 90 days and still
accruing are residential real estate loans with minimal loss expectations.
The reserve for loan losses represented 1.51% of loans as of September 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 September 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 September 30, 2001.
Capital resources. Shareholders' equity has increased by $11.4 million since
December 31, 2001 due to the retained earnings of $9.2 million, an increase in
accumulated other comprehensive income ("OCI") of $5.4 million and an increase
in common stock of $3.5 million (due primarily to the acquisition of
Stouffer-Herzog). Somewhat offsetting these increases was the addition of $6.8
million in treasury stock. The Company repurchased nearly 296,000 shares during
the first nine months 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.
12
(Dollars in thousands, except per share data)
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 $28 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 $3
million in outstanding balances against the unsecured lines of credit as of
September 30, 2002.
Results of Operations
Quarterly Comparison
The Company reported net operating income of $5,536 for the third quarter of
2002. Net income for the third quarter represented fifty-five cents ($.55) per
share on a diluted basis. Return on average assets (ROA) and return on average
total shareholders' equity (ROE) were 1.25% and 16.22%, respectively, for the
third quarter of 2002 compared to 1.11% and 13.87% for last year's third
quarter. Net interest income increased from $12,473 for the third quarter of
2001 to $13,954 for this year's third quarter. The 11.9% improvement was
primarily the result of an increase in average earning assets, primarily
generated through the Commerce acquisition. Average earning assets increased by
10.9% from last year to average $1,657,438 in the most recent quarter. The net
interest margin remained stable from last year's third quarter at 3.49%. The
efficiency ratio was slightly improved, decreasing from 57.89% for the third
quarter of 2001 to 56.94% for this year's third quarter. Increased gains on the
sale of loans generally offset increases in expenses, primarily driven by
increased salary and benefit costs.
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 45% of our total loan portfolio
at September 30, 2002, up from 40% at the end of the third quarter in 2001. The
increase is primarily due to loan balances acquired via the commerce
acquisition. Loan volume generated for the third quarter of 2002 totaled $58.2
million versus $45.8 million for the same period in 2001. Loan balances have
actually increased by $34.5 million since June 30, 2002 due to 1) the transfer
to approximately $12 million in loans previously classified as consumer loans to
commercial loans and 2) the increase in new loan generation. The increase in
loan generation can be attributed to increase lending activity in the newer
western-most regions of the Company's market. 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
September 30, 2002, approximately 28% of loans were consumer loans. Of these
balances, 39% were related to indirect automobile, boat and recreational vehicle
lending compared to 45% as of September 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 increased from
$6.8 million during the third quarter of 2001 to $14.8 million during the third
quarter of 2002. Direct consumer lending has increased from $32.2 million for
the third quarter of 2001 to $33.9 million for this year's third quarter.
13
(Dollars in thousands, except per share data)
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 $207 million in
residential real estate loans and sold approximately $169 million of loans
during the third quarter of 2002, generating a net gain of $2,306.
Comparatively, we originated $156 million and sold $120 million during the third
quarter of 2001, generating net gains on sale of $1,358. We service $1.12
billion in mortgage loans for others at September 30, 2002 versus $652 million
as of September 30, 2001. Due to the continuation of lower mortgage interest
rates in the third quarter of 2002, the valuation allowance on mortgage
servicing rights associated with these serviced loans increased to a total of
$3,087 as of September 30, 2002, compared to an allowance of $505 as of
September 30, 2001. Included in other income during the third quarters of 2002
and 2001 were valuation allowance impairment charges of $802 and $475,
respectively. Typically the impact of the changes in the valuation allowance are
offset by the gains realized on new residential real estate production. The risk
of negative impacts to earnings was partially reduced by the acquisition of $300
million in notional value of interest rate floors at the end of the second
quarter of 2002. 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. Included
in other income in 2002 was income from the changes in market values of the
floors of $1,087.
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 third 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 is planning to discontinue the use of
internally managed common trust funds, except for a tax-free municipal fund,
during the fourth quarter of 2002. The change is not expected to have a material
impact on fee income. Fee income is down 21.7% from the third quarter of 2001
due the negative impact of current market conditions on asset values. Our trust
department had approximately $528 million in assets under management at
September 30, 2002 as compared to $624 million at December 31, 2001.
Insurance. The acquisition of Stouffer-Herzog on September 4, 2002 had a
relatively minor impact on earnings for the quarter. The agency has provided
insurance services to Ohio residents since 1956. Stouffer-Herzog has a diverse
income base by line of business. Commission historically are derived from
personal lines (42%), commercial lines (35%) and life and health lines (23%).
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 $1,573 for the third quarter
of 2002 versus $988 during the same period in 2001. Total net charge-offs were
$940 for the third quarter of 2002 versus $1,168 for the third quarter of 2001.
Loan losses are expected to remain slightly above their historical level of .30%
of gross loans for the next several quarters, primarily due to continued soft
economic conditions and their impact on our commercial borrowers. Consumer
charge-offs are expected to be no greater than the previous year for the fourth
quarter due to the improvement in the asset quality of the consumer portfolio
brought about by the de-emphasis on indirect automobile lending.
14
(Dollars in thousands, except per share data)
Non-interest Income. Non-interest income (excluding security and trading gains
and losses) totaled $6,329 for the third quarter of 2002 versus $4,420 for the
same period last year. The improvement is primarily the result of improvement in
the gain on sale of loans, which increased 73.7% to $2.421 in the third quarter
of 2002 due to the increase in mortgage lending activities. The improvement in
non-interest income can also be attributed to the increase in deposit service
charges of 12%, resulting from an increase in core transaction accounts.
Additionally, included in other income during the third quarters of 2002 and
2001 were valuation allowance impairment charges of $802 and $475, respectively.
Also included in other income in the third quarter of 2002 was income from the
changes in market values of the floors of $1,087. The Company had no interest
rate floors during the third quarter of 2001.
Non-interest Expense. Expenses for the third quarter of 2002 were $11,841, up
17.4% 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 22.2% to $6,494
from the third quarter of 2001 while occupancy expense increased by 11.8% to
$1,119. Non-interest expenses increased from the linked quarter by $558, or 4.9%
due to increased legal costs associated with problem credits and $124 in merger
costs from the Stouffer-Herzog acquisition.
Year-to-date Comparison
The Company reported net operating income of $14,572 for the first nine months
of 2002. Net income for the first nine months represented ninety cents ($1.45)
per share on a diluted basis. Return on average assets (ROA) and return on
average total shareholders' equity (ROE) were 1.12% and 14.59%, respectively,
for the first nine months of 2002 compared to 1.09% and 13.97% for last year's
first nine months. Net interest income increased from $36,687 for the first nine
months of 2001 to $42,514 for this year's first nine months. The 15.9%
improvement was the result of an improved net interest margin, which increased
to 3.63% for the first nine months 2002 from 3.47% from the first nine months of
2001 as well as an 9.69% increase in average earning assets, primarily generated
through the Commerce acquisition. The efficiency ratio was slightly increased,
from 58.20% for the first nine months of 2001 to 58.59% for this year's first
nine months. The increase in valuation adjustments for mortgage servicing rights
was the primary reason for the increase.
Commercial Lending. Loan volume generated for the first nine months of 2002
totaled $151 million versus $127 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 from $48 million during the
first nine months of 2001 to $42 million during the first nine months of 2002.
Recently, the indirect volume has increased with the commencement of indirect
boat and recreational vehicle lending. Conversely, direct consumer lending has
increased by 23% from $90 million for the first nine months of 2001 to $110
million for this year's first nine months.
Mortgage Banking. We originated $557 million in residential real estate loans
and sold approximately $505 million of loans during the first nine months of
2002, generating a net gain of $5,166. Comparatively, we originated $357 million
and sold $295 million during the first nine months of 2001, generating net gains
of $2,967. The Company continues to diversify and expand its origination sources
for real estate mortgages utilizing correspondents, originators and banking
center staff.
15
(Dollars in thousands, except per share data)
Trust. During the first nine months of 2002, personal trust accounts and
employee benefit accounts produced approximately 73% and 27% of the total
revenues of $2,078 of the department, respectively. Fee income is down 8.3% from
the first nine months of 2001 due the negative impact of current market
conditions on asset values
Provision for loan losses. The provision for loan losses was $3,809 for the
first nine months of 2002 versus $3,091 during the same period in 2001. Total
net charge-offs were $3,061 for the first nine months of 2002 versus $2,879 for
the same period in 2001. The 6% increase is due to generally weaker economic
conditions impacting the Company's commercial borrowers ability to repay.
Non-interest Income. Non-interest income (excluding security gains and losses
and trading activity) totaled $15,539 for the first nine months of 2002 versus
$13,022 for the same period last year. This improvement of 19.3% is primarily
attributable to a 9.2% improvement in service charges on deposit accounts (due
to an increase in core transaction accounts) and a 72.8% 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 nine months of 2002 were $34,921,
up 16.6% from the same period last year due to 1) the impact on personnel and
occupancy costs from the additional banking centers acquired from Commerce, 2)
an increase in staff to manage the increased mortgage banking activities, 3) a
$141 write-down in other real estate owned property and 4) $124 in merger costs
associated with the acquisition of Stouffer-Herzog.
16
(Dollars in thousands, except per share data)
Item 3. Qualitative and Quantitative Disclosure About Market Risk
Forward-looking statements
The section that follows contains certain forward-looking statements (as defined
in the Private Securities Litigation Reform Act of 1995). These forward-looking
statements may involve significant risks and uncertainties. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, actual results may differ materially from the expectations discussed
in these forward-looking statements.
Market Risk Management
Market risk is the risk of economic loss from adverse changes in the fair value
of financial instruments due to changes in (a) interest rates, (b) foreign
exchange rates, or (c) other factors that relate to market volatility of the
rate, index, or price underlying the financial instrument. The Company's market
risk is composed primarily of interest rate risk. The Company's Asset/Liability
Committee ("ALCO") is responsible for reviewing the interest rate sensitivity
position of the Company and establishing policies to monitor and limit the
exposure to interest rate risk. Since nearly the Company's entire interest rate
risk exposure relates to the financial instrument activity of the Bank, the
Bank's Board of Directors review the policies and guidelines established by
ALCO.
The primary objective of asset/liability management is to provide an optimum and
stable net interest margin, after-tax return on assets and return on equity
capital, as well as adequate liquidity and capital. Interest rate risk is
monitored through the use of two complementary measures: dynamic gap analysis
and earnings simulation models. While each of the measurement techniques has
limitations, taken together they represent a reasonably comprehensive tool for
measuring the magnitude of interest rate risk inherent in the Company.
The earnings simulation model forecasts earnings for a one-year horizon frame
under a variety of interest rate scenarios; including interest rate shocks,
stepped rates and yield curve shifts. Management evaluates the impact of the
various rate simulations against earnings in a stable interest rate environment.
The most recent model projects net interest income would increase by 2.9% if
interest rates would immediately rise by 200 basis points. It projects a
decrease in net interest income of 1.4% 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.
17
Item 4. Controls and Procedures
As of September 30, 2002, an evaluation was performed under the supervision and
with the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures, in
accordance with Rules 13a-14 and 13a-15 of the Securities Exchange Act of 1934.
Based on that evaluation, the Company's management, including the Chief
Executive Officer and Chief Financial Officer, concluded that the Company's
disclosure controls and procedures were effective as of September 30, 2002.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
September 30, 2002.
18
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:
a. Exhibits. The following exhibits are included herein:
Exhibit 11.1 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
b. Reports on Form 8-K. The Company filed the following reports on Form 8-K
during the quarter ended September 30, 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. The Company also
filed a report on Form 8-K on September 3, 2002 to announce the acquisition of
Stouffer-Herzog Insurance Agency, Inc. and Stouffer-Herzog Financial Services
Agency, Inc. In the fourth quarter, the Company has filed the following reports
on Form 8-K: The Company filed a report on Form 8-K on October 17, 2002 to
announce earnings for the third quarter 2002. The Company filed a report on Form
8-K on October 28, 2002 to announce the sale of two branches of subsidiary
Second National Bank of Warren.
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.
SECOND BANCORP INCORPORATED
CERTIFICATIONS
I, Rick L. Blossom, Chairman, President and Chief Executive Officer, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Second Bancorp
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 12, 2002 /s/ Rick L. Blossom
----------------------------------
Chairman, President and
Chief Executive Officer
20
CERTIFICATIONS
I, David L. Kellerman, Treasurer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Second Bancorp
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 12, 2002 /s/ David L. Kellerman
----------------------------------
Treasurer
(Chief Financial Officer)
21