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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
Commission File No. 1-14473
Sky Financial Group, Inc.
(Exact Name of Registrant as Specified in its Charter)
Ohio 34-1372535
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
221 South Church Street, Bowling Green, Ohio 43402
(Address of Principal Executive Offices) (Zip Code)
(419) 327-6300
(Registrant's Telephone Number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
The number of shares outstanding of the Registrant's common stock, without par
value, was 82,052,367 at July 31, 2002.
SKY FINANCIAL GROUP, INC.
INDEX
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets
June 30, 2002 and December 31, 2001 .................. 3
Consolidated Statements of Income
Three months ended June 30, 2002 and 2001 and
Six months ended June 30, 2002 and 2001 ............ 4
Condensed Consolidated Statements of Changes in
Shareholders' Equity
Three months ended June 30, 2002 and 2001 and
Six months ended June 30, 2002 and 2001 ............ 5
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2002 and 2001 .............. 6
Notes to Consolidated Financial Statements ............. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................. 17
Item 3. Quantitative and Qualitative Disclosures
About Market Risk .................................... 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................... 31
Item 2. Changes in Securities and Use of Proceeds .............. 31
Item 3. Defaults Upon Senior Securities ........................ 31
Item 4. Submission of Matters to a Vote of Security Holders .... 31
Item 5. Other Information ...................................... 31
Item 6. Exhibits and Reports on Form 8-K ....................... 31
SIGNATURES ....................................................... 32
EXHIBIT INDEX .................................................... 33
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SKY FINANCIAL GROUP, INC.
Consolidated Balance Sheets (Unaudited) June 30, December 31,
(Dollars in thousands, except share data) 2002 2001
- ------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 200,033 $ 272,196
Interest-earning deposits
with financial institutions 62,497 39,171
Federal funds sold -- 8,000
Loans held for sale 11,648 85,474
Securities available for sale 2,188,340 1,996,843
Total loans 6,859,283 6,473,989
Less allowance for credit losses (108,065) (103,523)
---------- ----------
Net loans 6,751,218 6,370,466
Premises and equipment 112,068 112,137
Goodwill and other intangibles 78,323 60,710
Accrued interest receivable and other assets 324,220 275,231
---------- ----------
TOTAL ASSETS $9,728,347 $9,220,228
========== ==========
LIABILITIES
Deposits
Non-interest-bearing deposits $ 867,553 $ 822,436
Interest-bearing deposits 6,000,682 5,719,741
---------- ----------
Total deposits 6,868,235 6,542,177
Securities sold under repurchase
agreements and federal funds purchased 751,908 685,450
Debt and Federal Home Loan Bank advances 1,153,887 1,095,545
Obligated mandatorily redeemable capital
securities of subsidiary trusts 109,625 108,600
Accrued interest payable
and other liabilities 145,349 140,012
---------- ----------
TOTAL LIABILITIES 9,029,004 8,571,784
---------- ----------
SHAREHOLDERS' EQUITY
Serial preferred stock, $10.00 par value;
10,000,000 shares authorized; none issued -- --
Common stock, no par value;
150,000,000 shares authorized;
83,988,472 and 84,011,214 shares
issued in 2002 and 2001 596,747 596,397
Retained earnings 116,044 86,113
Treasury stock; 1,559,634 and
2,164,099 shares in 2002 and 2001 (34,339) (39,505)
Unearned ESOP (123) (123)
Accumulated other comprehensive income 21,014 5,562
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 699,343 648,444
---------- ----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $9,728,347 $9,220,228
========== ==========
The accompanying notes are an integral part of the financial statements.
3
SKY FINANCIAL GROUP, INC.
Consolidated Statements of Income (Unaudited)
Three Months Ended Six Months Ended
(Dollars in thousands, June 30, June 30,
except per share data) 2002 2001 2002 2001
- -----------------------------------------------------------------------------
Interest Income
Loans, including fees $123,411 $130,886 $245,140 $263,162
Securities
Taxable 30,350 29,061 59,626 58,291
Nontaxable 450 494 837 1,038
Federal funds sold and other 207 621 414 1,280
-------- -------- -------- --------
Total interest income 154,418 161,062 306,017 323,771
-------- -------- -------- --------
Interest Expense
Deposits 45,734 57,270 92,085 117,545
Borrowed funds 21,331 24,047 42,603 49,704
-------- -------- -------- --------
Total interest expense 67,065 81,317 134,688 167,249
-------- -------- -------- --------
Net Interest Income 87,353 79,745 171,329 156,522
Provision for Credit Losses 9,444 8,568 18,765 15,224
-------- -------- -------- --------
Net Interest Income After
Provision for Credit Losses 77,909 71,177 152,564 141,298
-------- -------- -------- --------
Non-interest Income
Trust services income 3,564 3,749 7,017 7,455
Service charges and fees on
deposit accounts 8,379 7,628 15,989 14,537
Mortgage banking income 4,497 6,054 9,950 10,706
Brokerage & insurance commissions 9,554 5,253 18,286 14,027
Net securities gains 940 443 1,445 1,368
Other income 8,262 7,221 15,332 14,426
-------- -------- -------- --------
Total non-interest income 35,196 30,348 68,019 62,519
-------- -------- -------- --------
Non-interest Expense
Salaries and employee benefits 36,241 30,794 70,988 61,999
Occupancy and equipment expense 9,058 9,001 17,887 18,218
Merger, integration and
restructuring expense 5,652 5,652
Amortization expense 1,197 1,166 2,394 2,324
Other operating expense 17,995 17,199 33,753 34,858
-------- -------- -------- --------
Total non-interest expense 70,143 58,160 130,674 117,399
-------- -------- -------- --------
Income Before Income Taxes 42,962 43,365 89,909 86,418
Income taxes 14,064 14,133 29,524 28,349
-------- -------- -------- --------
Net Income $ 28,898 $ 29,232 $ 60,385 $ 58,069
======== ======== ======== ========
Earnings Per Common Share
Basic $ 0.35 $ 0.35 $ 0.73 $ 0.70
Diluted $ 0.35 $ 0.35 $ 0.73 $ 0.70
The accompanying notes are an integral part of the financial statements.
4
SKY FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
Three Months Ended Six Months Ended
(Dollars in thousands, June 30, June 30,
except per share data) 2002 2001 2002 2001
- ----------------------------------------------------------------------------
Balance at beginning of period $671,171 $622,446 $648,444 $609,690
Comprehensive income
Net income 28,898 29,232 60,385 58,069
Other comprehensive income 19,924 4,871 15,452 12,253
-------- -------- -------- --------
Total comprehensive income 48,822 34,103 75,837 70,322
Common cash dividends (15,670) (14,873) (31,374) (29,855)
Treasury shares acquired (7,340) (11,220) (13,308) (20,001)
Treasury shares issued for stock
option exercises 861 1,759 2,305 2,513
Shares issued to acquire Celaris
Group, Inc. -- -- 15,349 --
Fractional shares & other items 1,499 (52) 2,090 (506)
-------- -------- -------- --------
Balance at end of period $699,343 $632,163 $699,343 $632,163
======== ======== ======== ========
Common cash dividends per share $ 0.19 $ 0.18 $ 0.38 $ 0.36
The accompanying notes are an integral part of the financial statements.
5
SKY FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
(Dollars in thousands) June 30,
2002 2001
- -----------------------------------------------------------------------
Net Cash From Operating Activities $ 113,787 $ 37,080
--------- ---------
Investing Activities
Net decrease in interest-bearing
deposits in other banks (23,326) (1,363)
Net increase in federal funds sold 8,000 --
Securities available for sale:
Proceeds from maturities and payments 447,980 413,211
Proceeds from sales 130,559 74,400
Purchases (749,833) (475,177)
Proceeds from sales of loans 14,612 13,682
Net increase in loans (417,276) (331,731)
Purchases of premises and equipment (7,331) (4,069)
Proceeds from sales of premises and equipment 312 3,016
Proceeds from sales of other real estate 1,657 1,475
Cash paid to acquire Celaris Group, Inc. (1,000) --
Cash paid to acquire Value Added Benefits, Ltd. (1,900) --
--------- ---------
Net cash from investing activities (597,546) (306,556)
--------- ---------
Financing Activities
Net increase in deposit accounts 326,058 204,397
Net increase in federal funds
and repurchase agreements 66,458 12,134
Net increase in borrowings
under bank lines of credit 3,839 77,808
Net increase in short-term FHLB
advances 83,000 20,000
Proceeds from issuance of debt
and long-term FHLB advances 236,443 84,495
Repayment of debt and long-term
FHLB advances (263,915) (78,022)
Cash dividends and fractional shares paid (29,284) (30,015)
Proceeds from issuance of common stock 2,305 2,513
Treasury stock purchases (13,308) (20,001)
--------- ---------
Net cash from financing activities 411,596 273,309
--------- ---------
Net change in cash and due from banks (72,163) 3,833
Cash and due from banks at beginning of year 272,196 266,359
--------- ---------
Cash and due from banks at end of period 200,033 270,192
========= =========
Supplemental Disclosures
Interest paid $ 140,568 $ 169,403
Income taxes paid 31,602 25,832
Noncash transactions - shares issued
to acquire Celaris Group, Inc. 15,349
The accompanying notes are an integral part of the financial statements.
6
SKY FINANCIAL GROUP, INC.
Notes to Consolidated Financial Information (Unaudited)
(Dollars in thousands, except per share data)
1. Accounting Policies
Sky Financial Group, Inc. (Sky Financial) is a financial holding company
headquartered in Bowling Green, Ohio that owns and operates Sky Bank which is
primarily engaged in the commercial and consumer banking business in Ohio,
southern Michigan, western Pennsylvania, West Virginia and Indiana. Sky
Financial also operates businesses relating to commercial finance lending,
insurance, trust and other related financial services.
The accounting and reporting policies followed by Sky Financial conform in all
material respects to accounting principles generally accepted in the United
States of America (US GAAP) and to general practices within the financial
services industry. The preparation of financial statements in conformity with US
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements. Actual results could
differ from those estimates. The allowance for credit losses and fair values of
financial instruments are particularly subject to change.
These interim financial statements are prepared without audit and reflect all
adjustments of a normal recurring nature which, in the opinion of management,
are necessary to present fairly the consolidated financial position of Sky
Financial at June 30, 2002, and its results of operations and cash flows for the
periods presented. Certain amounts in prior financial statements have been
reclassified to conform to the current presentation. The accompanying
consolidated financial statements do not contain all financial disclosures
required by US GAAP. Sky Financial's Annual Report for the year ended December
31, 2001, contains consolidated financial statements and related notes which
should be read in conjunction with the accompanying consolidated financial
statements.
New Accounting Pronouncements
During 2002, the Company adopted Statement of Financial Accounting Standard
(SFAS) No. 143, "Accounting for Asset Retirement Obligations." This Statement
addresses financial accounting and reporting for legal obligations associated
with the sale, abandonment, disposal, recycling or other than temporary removal
from service of tangible long-lived assets. SFAS No. 143 requires an asset
retirement obligation to be recognized at fair value when it is incurred, if a
reasonable estimate of its fair value can be made at the time. Otherwise, the
obligation should be recorded as soon as its fair value can be reasonable
estimated. This statement, which is effective for the Company on January 1,
2003, is not expected to have a material impact on the Company.
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
144, "Accounting for the Impairment and Disposal of Long-Term Assets." This
Statement eliminates the allocation of goodwill to long-lived assets to be
tested for impairment and details both a probability-weighted and
"primary-asset" approach to estimate cash flows in testing for impairment of a
long-
7
lived asset. Adoption of SFAS No. 144 on January 1, 2002 did not have a material
effect on the Company.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This Statement eliminates inconsistencies between the required accounting for
sale-leaseback transactions. The adoption of SFAS No. 145 during May 2002 did
not have a material effect on the Company.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities." This statement addresses the timing of recognition
of a liability for exit and disposal costs at the time a liability is incurred,
rather than at a plan commitment date, as previously required by US GAAP. Exit
or disposal costs will be measured at the fair value and will be subsequently
adjusted for changes in estimated cash flows. This statement is effective for
the company beginning in fiscal 2003 and is not expected to have a material
effect on the Company.
2. Mergers, Acquisitions and Divestitures
In May 2002, Sky Financial announced that a definitive agreement had been
reached to acquire Three Rivers Bancorp, a $1 billion bank holding company
located in Monroeville, Pennsylvania and its wholly-owned subsidiary, Three
Rivers Bank and Trust Company (collectively known as Three Rivers). Pursuant to
the definitive agreement, stockholders of Three Rivers will be entitled to elect
to receive, in exchange for each share of the Three Rivers' common stock held,
either $18.27 in cash or .80 shares of the Company, or combination thereof.
These election are subject to adjustment to ensure that in aggregate, 75% of
Three Rivers' common shares will be exchanged for shares of the Company's common
stock and 25% of Three Rivers' common shares will be exchanged for cash. When
announced on May 7, 2002, Sky Financial's purchase price was valued at $153.8
million, including the cost to acquire Three River's outstanding stock options.
Pending approval by shareholders of Three Rivers and various regulatory
agencies, the transaction is expected to close at the beginning of the fourth
quarter 2002.
In April 2002, Sky Financial acquired Value Added Benefits, Ltd., a wholesale
insurance agency headquartered in Cleveland, Ohio, for $1.9 million in cash.
In January 2002, Sky Financial completed the acquisition of Celaris, Group,
Inc., a full service insurance agency headquartered in Bowling Green, Ohio. In
connection with the acquisition, Sky Financial paid $1 million in cash and
issued .75 million shares of Sky Financial stock.
In October 2001, Sky Financial completed its purchase of ten branch offices from
Standard Federal Bank of Troy, Michigan. In connection with the acquisition, Sky
Bank assumed approximately $290,000 of deposit liabilities, while Standard
Federal Bank retained substantially all loans associated with the branches.
In September 2001, Sky Financial acquired substantially all of the assets of
Barney C. Guttman and Associates, Inc., an investment management and financial
services firm for $.6 million in cash.
In March 2001, Sky Financial completed the sale of Sky Investments, Inc., its
independent broker/dealer business and Sky Insurance Agency, Inc. The sale
resulted in a $.634 milion pre-tax gain.
8
3. Securities Available for Sale
The unrealized gains and losses and estimated fair values at June 30, 2002 and
December 31, 2001 are as follows:
Estimated Gross Gross
Fair Unrealized Unrealized
June 30, 2002 Value Gains Losses
- ----------------------------------------------------------------
U.S. Treasury and U.S.
Government agencies $ 482,817 $ 9,377 $ --
Obligations of states and
political subdivisions 29,966 367 (33)
Corporate and other
securities 77,611 1,003 (1,859)
Mortgage-backed
securities 1,492,311 26,875 (43)
---------- ------- -------
Total debt securities
available for sale 2,082,705 37,622 (1,935)
Marketable equity
securities 105,635 7,625 (3,212)
---------- ------- --------
Total securities
available for sale $2,188,340 $45,247 $ (5,147)
========== ======= ========
December 31, 2001
- -----------------
U.S. Treasury and U.S.
Government agencies $ 494,474 $11,717 $ (9)
Obligations of states and
political subdivisions 32,912 255 (311)
Corporate and other
securities 75,744 527 (2,864)
Mortgage-backed
securities 1,279,227 12,706 (8,044)
---------- ------- --------
Total debt securities
available for sale 1,882,357 25,205 (11,228)
Marketable equity
securities 114,486 7,903 (4,392)
---------- ------- --------
Total securities
available for sale $1,996,843 $33,108 $(15,620)
========== ======= ========
9
4. Loans
The loan portfolios are as follows:
June 30, 2002 December 31, 2001
- ---------------------------------------------------------------------
Real estate loans:
Construction $ 319,732 $ 295,154
Residential mortgage 1,522,250 1,675,957
Non-residential mortgage 1,791,388 1,719,074
Commercial, financial and
agricultural 2,305,579 2,127,045
Installment and credit card loans 879,895 638,958
Other loans 40,439 17,801
---------- ----------
Total loans $6,859,283 $6,473,989
========== ==========
The following table presents the aggregate amounts of non-performing loans on
the dates indicated.
June 30, 2002 December 31, 2001
- ---------------------------------------------------------------------
Non-accrual loans $56,876 $33,319
Restructured loans 3,840 785
------- -------
Total non-performing loans $60,716 $34,104
======= =======
Total non-performing loans increased $26,612 during the six months ended June
30, 2002 primarily as a result of the addition of $22.8 million of loans that
are secured by pools of commercial leases for which payment is over 90 days past
due. See Note 12 "Commitments and Contingencies" for additional discussion.
5. Borrowings
Sky Financial's debt, Federal Home Loan Bank (FHLB) advances and obligated
mandatorily redeemable capital securities of subsidiary trusts are comprised of
the following:
June 30, 2002 December 31, 2001
- ----------------------------------------------------------------------------
Borrowings under bank lines of credit $ 93,000 $ 89,161
Asset backed notes
2001-A, Class A-1, due December 2011
at 6.425% 31,670 36,155
2001-A, Class A-2, due December 2011
at 9.95% 45,000 45,000
2001-B, Class A-1, due July 2012
at 5.55% 49,184 54,215
2001-B, Class A-2, due July 2012
at 6.39% 49,760 49,760
2001-C, Class A-1. due January 2013
at 4.555% 31,871 33,000
2001-C, Class A-2, due January 2013
at 5.925% 72,000 72,000
2002-A, Class A-1, due July 2018
at 5.398% 60,000 --
2002-A, Class A-2, due July 2018
at 6.705% 90,000 --
Borrowings under FHLB lines of credit 579,388 662,216
Subordinated note, 7.08%, January 2008 50,000 50,000
Obligated mandatorily redeemable capital
securities of subsidiary trusts
Due February 2027 at 9.875% 25,000 25,000
Due June 2027 at 10.20% 23,600 23,600
Due May 2030 at 9.34% 60,000 60,000
Capital lease obligations 1,496 1,496
Other items 1,543 2,542
---------- ----------
Total borrowings $1,263,512 $1,204,145
========== ==========
10
SFS's warehouse line of credit is included under bank lines of credit and was
$19,161 at December 31, 2001. SFS had no borrowings under the warehouse line of
credit at June 30, 2002.
During March 2002, Sky Financial entered into interest rate swap arrangements to
exchange the rate of borrowings on $35,000 of the 9.34% trust preferred security
due May 2030 and $25,000 of the 9.875% trust preferred security due February
2027 for variable rate payments based on LIBOR plus a spread as defined in the
agreement. At June 30, 2002, the swaps had a fair market value of $1,025. The
interest rate swaps involve no exchange of principal either at inception or
maturity and have maturities and call options identical to the trust preferred
security agreements. The arrangements have been designated as fair value hedges
and both the change in the fair value of the hedges and the hedged transactions
are reflected in earnings.
During May 2002, Sky Financial, through one of its affiliates, issued $150,000
of fixed interest rate asset-backed notes to provide term funding for commercial
loans.
The expected final payment dates for the asset backed notes listed above are
included in the following table:
Stated Expected Final
Maturity Date Payment Date
- ------------------------------------------------------
2001-A, Class A-1 December 2011 October 2005
2001-A, Class A-2 December 2011 July 2009
2001-B, Class A-1 July 2012 July 2005
2001-B, Class A-2 July 2012 April 2007
2001-C, Class A-1 January 2013 October 2005
2001-C, Class A-2 January 2013 August 2010
2002-A, Class A-1 July 2018 October 2007
2002-A, Class A-2 July 2018 July 2012
6. Other Comprehensive Income
Other comprehensive income consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------
Securities available for sale:
Unrealized securities gain (loss)
arising during period $32,457 $7,021 $24,567 $22,963
Reclassification adjustment for
(gains)losses included in income (940) (443) (1,445) (1,368)
------- ------ ------- -------
31,517 6,578 23,122 21,595
------- ------ ------- -------
Cash flow hedge derivatives:
Adoption of SFAS No.133 (1,231)
Change in fair value of cash flow
hedge derivatives (894) 695 91 270
Amounts reclassified to
interest expense 30 221 560 (1,784)
------- ------ ------- -------
(864) 916 651 (2,745)
------- ------ ------- -------
Net unrealized gain (loss) 30,653 7,494 23,773 18,850
Tax effect 10,729 2,623 8,321 6,597
------- ------ ------- -------
Total other comprehensive income $19,924 $4,871 $15,452 $12,253
======= ====== ======= =======
11
7. Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted
average number of shares outstanding during the period. Diluted earnings per
share is computed using the weighted average number of shares determined for the
basic computation plus the dilutive effect of potential common shares issuable
under stock options. For the three months ended June 30, 2002 and 2001, 875,970
and 1,651,000 weighted shares, respectively, under option were excluded from the
diluted earnings per share calculation as they were anti-dilutive. For the six
months ended June 30, 2002 and 2001, 1,430,000 and 1,956,000 weighted shares,
respectively, under option were excluded from the diluted earnings per share
calculation as they were anti-dilutive.
The weighted average number of common shares outstanding for basic and diluted
earnings per share computations were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Numerator:
Net income $ 28,898 $ 29,232 $ 60,385 $ 58,069
=========== =========== =========== ===========
Denominator:
Weighted-average
common shares
outstanding (basic) 82,358,000 82,694,000 82,343,000 82,919,000
Effect of stock options 872,000 587,000 801,000 504,000
----------- ----------- ----------- -----------
Weighted-average
common shares
outstanding (diluted) 83,230,000 83,281,000 83,144,000 83,423,000
========== =========== =========== ===========
Earnings per share:
Basic $ 0.35 $ 0.35 $ 0.73 $ 0.70
Diluted $ 0.35 0.35 0.73 0.70
8. Capital Resources
The Federal Reserve Board (FRB) has established risk-based capital guidelines
that must be observed by financial holding companies and banks. Failure to meet
specified minimum capital requirements can result in certain mandatory actions
by primary regulators of Sky Financial and its bank subsidiary that could have a
material effect on Sky Financial's financial condition or results of operations.
Under capital adequacy guidelines, Sky Financial and its bank subsidiary must
meet specific quantitative measures of their assets, liabilities and certain off
balance sheet items as determined under regulatory accounting practices. Sky
Financial's and its bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk weightings and
other factors. Management believes, as of June 30, 2002, that Sky Financial and
its bank meet all capital adequacy requirements to which they are subject.
Sky Financial and its bank have been notified by their respective regulators
that, as of the most recent regulatory examinations, each is regarded as well
capitalized under the regulatory framework for prompt corrective action. Such
determinations have been made evaluating Sky Financial and its bank under Tier
I, total capital, and leverage ratios. There are no conditions or
12
events since these notifications that management believes have changed any of
the well capitalized categorizations of Sky Financial and its bank subsidiary.
Sky Financial's capital ratios are presented in the following table:
June 30, 2002 December 31, 2001
- --------------------------------------------------------------------
Total adjusted average assets
for leverage ratio $9,551,205 $9,052,525
Risk-weighted assets and
off-balance-sheet financial
instruments for capital ratio 7,881,746 7,329,032
Tier I capital 702,591 684,685
Total risk-based capital 854,204 830,000
Leverage ratio 7.4% 7.6%
Tier I capital ratio 8.9 9.3
Total capital ratio 10.8 11.3
Capital ratios applicable to Sky Financial's banking subsidiary at June 30, 2002
were as follows:
Total
Tier I Risk-based
Leverage Capital Capital
- -----------------------------------------------------------------
Regulatory Capital Requirements
Minimum 4.0% 4.0% 8.0%
Well-capitalized 5.0 6.0 10.0
Actual ratio
Sky Bank 6.6 8.6 10.7
In September, 2001, the Board of Directors of Sky Financial reauthorized
management to undertake purchases of up to an additional 2.5% (or approximately
2 million shares) of Sky Financial's outstanding common stock over a twelve
month period in the open market or in privately negotiated transactions. The
shares reacquired are held as treasury stock and reserved for use in future
stock dividends and use in its stock option plans or general corporate purposes.
As of June 30, 2002, Sky Financial had repurchased approximately 625,000 shares
of common stock pursuant to its 2001 repurchase program.
9. Goodwill and Intangible Assets
Net goodwill at June 30, 2002 and December 31, 2001, was $52,123 and $33,912
respectively. Effective January 1, 2002, Sky Financial adopted new accounting
guidance changing post-acquisition accounting for goodwill and certain
intangible assets. In accordance with this guidance, goodwill is not amortized
but is reviewed annually for impairment. Sky Financial has completed the initial
impairment test required by the new guidance and determined that goodwill
recorded at January 1, 2002 is not impaired.
The following table presents a reconciliation between originally reported net
income and net income adjusted for the effect of the new accounting
pronouncement:
13
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ------------------------------------------------------------------
Net income $28,898 $29,232 $60,385 $58,069
Effect of Goodwill
amortization expense
(net of tax) -- 303 -- 605
------- ------- ------- -------
Net income (adjusted) $28,898 $29,535 $60,385 $58,674
======= ======= ======= =======
Basic earnings per share:
Reported net income $ 0.35 $ 0.35 $ 0.73 $ 0.70
Goodwill amortization -- .01 -- .01
------- ------- ------- -------
Adjusted net income $ 0.35 $ 0.36 $ 0.73 $ 0.71
======= ======= ======= =======
There was no impact on diluted earnings per share for the adoption of this new
accounting pronouncement.
Net other intangible assets at June 30, 2002 and December 31, 2001 were $26,200
and $26,598, respectively. These assets consist primarily of core deposits
intangibles and are continuing to be amortized in accordance with the company's
policy. For the years ended December 31, 2003 through 2007, estimated future
amortization expense is approximately $4,930 per year.
10. Line of Business Reporting
Sky Financial manages and operates three major lines of business: community
banking, financial services affiliates and Sky Financial Solutions. Community
banking includes lending and related services to businesses and consumers,
mortgage banking and deposit-gathering. Commercial finance lending includes
specialized lending to health care professionals, primarily dentists. Other
financial service affiliates consist of non-banking companies engaged in
broker/dealer operations, non-conforming mortgage lending, trust and wealth
management, insurance and other financial-related services.
The reported line of business results reflect the underlying core operating
performance within the business units. Parent and Other is comprised of the
parent company and several smaller business units. It includes the net funding
cost of the parent company and intercompany eliminations. Expenses for centrally
provided services and support are fully allocated based principally upon
estimated usage of services. All significant non-recurring items of income and
expense company-wide are included in Parent and Other. Prior periods have been
presented to conform with current reporting methodologies. Substantially all of
Sky Financial's assets are part of the community banking line of business.
14
Selected segment information for the three months ended June 30, 2002 and 2001
is included in the following tables:
Financial Sky Parent
Three Months Ended Community Service Financial and
June 30, 2002 Banking Affiliates Solutions Other Total
- -------------------------------------------------------------------------------------------------
Net interest income $ 83,824 $ 226 $ 4,384 $ (1,081) $ 87,353
Provision for credit losses 7,574 180 1,690 -- 9,444
---------- ------- -------- -------- ----------
Net interest income after provision 76,250 46 2,694 (1,081) 77,909
Other income 23,567 12,615 793 (1,779) 35,196
Other expenses 51,310 10,698 6,070 2,065 70,143
---------- ------- -------- -------- ----------
Income (loss) before income taxes 48,507 1,963 (2,583) (4,925) 42,962
Income taxes 16,200 760 (944) (1,952) 14,064
---------- ------- -------- ------- ----------
Net income (loss) $ 32,307 $ 1,203 $ (1,639) $ (2,973) $ 28,898
========== ======= ======== ======== ==========
Goodwill at April 1, 2002 $ 29,561 $40,447 $ -- $ -- $ 70,008
Acquired goodwill -- 799 -- -- 799
---------- ------- -------- -------- ----------
Goodwill at June 30, 2002 $ 29,561 $41,246 $ -- $ -- $ 70,807
========== ======= ======== ======== ==========
Average assets 8,894,636 81,398 477,264 107,558 9,560,856
Depreciation and amortization 4,118 759 147 (361) 4,663
Financial Sky Parent
Three Months Ended Community Service Financial and
June 30, 2001 Banking Affiliates Solutions Other Total
- -------------------------------------------------------------------------------------------------
Net interest income $ 78,800 $ 336 $ 1,850 $(1,241) $ 79,745
Provision for credit losses 6,139 425 2,004 -- 8,568
---------- ------- -------- ------- ----------
Net interest income after provision 72,661 (89) (154) (1,241) 71,177
Other income 20,828 8,529 458 533 30,348
Other expenses 45,385 7,282 3,884 1,609 58,160
---------- ------- -------- ------- ----------
Income (loss) before income taxes 48,104 1,158 (3,580) (2,317) 43,365
Income taxes 16,064 511 (1,271) (1,171) 14,133
---------- ------- -------- ------- ----------
Net income (loss) $ 32,040 $ 647 $ (2,309) $(1,146) $ 29,232
========== ======= ======== ======= ==========
Average assets 8,142,840 61,160 205,017 95,653 8,504,670
Depreciation and amortization 2,981 334 139 1,138 4,592
15
Selected segment information for the six months ended June 30, 2002 and 2001 is
included in the following tables:
Financial Sky Parent
Six Months Ended Community Service Financial and
June 30, 2002 Banking Affiliates Solutions Other Total
- -----------------------------------------------------------------------------------------------
Net interest income $ 165,471 $ 502 $ 8,012 $(2,656) $ 171,329
Provision for
credit losses 15,578 360 2,827 -- 18,765
---------- ------- -------- ------- ----------
Net interest income
after provision 149,893 142 5,185 (2,656) 152,564
Other income 43,667 24,966 1,515 (2,129) 68,019
Other expenses 99,495 21,439 11,411 (1,671) 130,674
---------- ------- -------- ------- ----------
Income (loss) before
income taxes 94,065 3,669 (4,711) (3,114) 89,909
Income taxes 31,267 1,427 (1,687) (1,483) 29,524
---------- ------- -------- ------- ----------
Net income (loss) $ 62,798 $ 2,242 $ (3,024) $ 1,631) $ 60,385
========== ======= ======== ======= ==========
Goodwill at January 1, 2002 $ 29,561 $22,339 $ -- $ -- $ 51,900
Goodwill change
during period -- 18,907 -- -- 18,907
---------- ------- -------- ------- ----------
Goodwill at June 30, 2002 $ 29,561 $41,246 $ -- $ -- $ 70,807
========== ======= ======== ======= ==========
Average assets 8,814,440 78,229 437,522 94,288 9,424,479
Depreciation and
amortization 7,365 353 291 1,368 9,377
Financial Sky Parent
Six Months Ended Community Service Financial and
June 30, 2001 Banking Affiliates Solutions Other Total
- -----------------------------------------------------------------------------------------------
Net interest income $ 155,208 $ 721 $ 3,074 $ (2,481) $ 156,522
Provision for
credit losses 11,210 575 3,439 -- 15,224
---------- ------- -------- -------- ----------
Net interest income
after provision 143,998 146 (365) (2,481) 141,298
Other income 38,473 21,081 1,014 1,951 62,519
Other expenses 89,970 17,932 7,559 t 1,938 117,399
---------- ------- -------- -------- ----------
Income (loss) before
income taxes 92,501 3,295 (6,910) (2,468) 86,418
Income taxes 30,797 1,410 (2,458) (1,400) 28,349
---------- ------- -------- -------- ----------
Net income (loss) $ 61,704 $ 1,885 $ (4,452) $ (1,068) $ 58,069
========== ======= ======== ======== ==========
Average assets 8,093,183 62,901 177,312 102,386 8,435,782
Depreciation and
amortization 5,986 711 281 2,290 9,268
16
11. Merger, Integration and Restructuring Expense
During June 2002, Sky Financial recorded merger, integration and restructuring
charges totaling $5,652 ($3,673 after tax or $.04 per diluted share). This
charge consisted of $1,401 related to severance and employee related expenses
and $373 in fixed asset impairment and lease abandonment costs. Additionally,
$411 in fixed asset additions and $3,467 in other synergy costs were incurred to
support Sky's new technology platform during the second quarter. Cash payments
for these charges will be made during the remainder of 2002 and be completed in
2003.
The following is a summery of activity in the merger, integration and
restructuring liability for the six months ended June 30, 2002:
Beginning balance $ 4,208
Accruals 5,652
Cash payments (2,499)
-------
Ending balance $ 7,361
=======
12. Commitments and Contingencies
Sky Financial is involved in litigation with three insurance companies who
issued surety bonds on insurance policies as security for four related loans
aggregating $22.8 million. The subject loans are secured by pools of commercial
leases, the payments under which are guaranteed by the surety bonds. Sky
Financial is engaged in litigation with these insurance companies to enforce the
payment obligations, as are a number of other banks nationwide. After
consultation with legal counsel, management believes that the credits are well
secured and the prospects for recovery of all principal and interest are good.
The entire portfolio has been placed on non-accrual status pending outcome of
the litigation.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(Dollars in thousands, except per share data)
Three Months Ended June 30, 2002 and 2001
Results of Operations
Operating earnings, which exclude non-recurring items, were $32,572 for the
second quarter of 2002, an increase of $3,340 compared to the second quarter of
2001 operating earnings of $29,232. Diluted operating earnings per common share
for the second quarter of 2002 was $0.39 ($0.40 basic) as compared to $0.35
($0.35 basic) for the second quarter of 2001). On an operating basis, return on
average equity (ROE) and return on average assets (ROA) were 18.91% and 1.37%,
respectively, for the second quarter of 2002 compared to 18.67% and 1.38%,
respectively, in 2001.
17
On a reported basis, net income was $28,898 for the three months ended June 30,
2002, a decrease of $334 compared to the same period in 2001. Reported net
income includes $3,673 in after-tax non-recurring expenses related to Sky's
implementation of a new technology platform company-wide. For the second quarter
of 2002, ROE and ROA were 16.78% and 1.21%, respectively, on a reported basis
compared to 18.67% and 1.38%, respectively, in 2001. Diluted earnings per common
share for the three months ended June 30, 2002 was $.35 ($.35 basic), consistent
with the same period in 2001.
Business Line Results
Sky Financial's business line results for the second quarter ended June 30, 2002
and 2001 are summarized in the table below.
Net Income (Loss)
Quarter Ended June 30, 2002 2001
- ---------------------------------------------------
Community Banking $32,307 $32,040
Financial Service Affiliates 1,203 647
Sky Financial Solutions, Inc. (1,639) (2,309)
Parent and Other (2,973) (1,146)
------- -------
Consolidated Total $28,898 $29,232
======= =======
The community banking net income for the second quarter of 2002 increased
slightly from 2001 second quarter earnings. This was primarily due to an
increase in net interest income and service charges on deposits and gains on
securities available for sale, offset by decreases in mortgage banking income
and a higher provision for loan loss. In addition, the community banking's net
income was lowered by the merger of the Company's technology services affiliate
into its community banking operations, resulting in higher employee costs offset
by lower equipment costs. The community banking efficiency ratio was 47.4% for
the second quarter of 2002 compared to 45.2% in the second quarter of 2001. The
2002 community banking results reflect a ROE of 19.69% and a ROA of 1.46%
compared to 21.87% and 1.58%, respectively, in the second quarter of 2001.
Sky Financial Solutions' loss decreased for the second quarter of 2002 as
compared to the same period in 2001 due to increased interest income as a result
of the continued growth in its retained loan portfolio. During the three months
ended June 30, 2002, Sky Financial Solutions added $63 million in new loans to
its portfolio.
The financial service affiliates' net income increased as compared to 2001 as a
result of the acquisition of two insurance companies during the year, offset by
a decline in net income at the company's trust operations.
Parent and other includes the net funding costs of the parent company and all
significant non-recurring items of income and expense. The results for the
second quarter of 2002 include after-tax non-recurring charges of $3,673 related
to Sky's implementation of a new technology platform.
Net Interest Income
Net interest income for the second quarter of 2002 was $87,353, an increase of
$7,608 or 9.5% from $79,745 in the second quarter of 2001. Net interest income,
the difference between interest income earned on interest-earning assets and
interest expense incurred on interest-bearing liabilities, is the most
significant component of the Company's earnings. Net interest income is affected
by changes in the volumes, rates and composition of interest-earning
18
assets and interest expense incurred on interest-bearing liabilities, is the
most significant component of the Company's earnings. Net interest income is
affected by changes in the volumes, rates and composition of interest-earning
assets and interest-bearing liabilities. Average earning assets increased 12.3%
from the second quarter last year, with continued strong growth in average
loans, increasing 10.4% from last year due in part to average loan growth at SFS
of $238,857 from the second quarter last year. Average deposits increased 14.0%
from the same quarter last year, which included organic growth of 8.5% and the
October 2001 acquisition of ten branches with $289 million in deposits. Sky
Financial's net interest margin for the three months ended June 30, 2002 was
3.94%, a decrease of 1 basis points from last quarter and 11 basis points from
the second quarter a year ago. The net interest rate margin was positively
impacted by $689 of net interest earned from interest rate swaps on the
Company's trust preferred securities, but was ultimately lower during the second
quarter of 2002 as compared to the same period in 2001 due to the initial lower
spread earned on the branch deposits acquired in the fourth quarter of last
year.
The following table reflects the components of Sky Financial's net interest
income for the three months ended June 30, 2002 and 2001. Rates are computed on
a tax equivalent basis and non-accrual loans have been included in the average
balances.
SKY FINANCIAL GROUP, INC.
Average Balance Sheets and Net Interest Margins
Three Months Ended Three Months Ended
(Dollars in thousands) June 30, 2002 June 30, 2001
- ------------------------------------------------------------------------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------
Interest-earning assets
Interest-earning deposits $ 43,176 $ 180 1.67% $ 14,434 $ 293 8.14%
Federal funds sold and other 7,189 27 1.50 24,200 328 5.44
Securities 2,215,580 31,657 5.73 1,850,250 29,918 6.49
Loans 6,710,375 123,411 7.38 6,092,795 131,392 8.65
---------- -------- ---------- --------
Total interest-earning assets 8,976,320 155,275 6.94 7,981,679 161,931 8.14
--------
Non-earning assets 584,535 522,991
---------- ----------
Total assets $9,560,855 $8,504,670
========== ==========
Interest-bearing liabilities
Demand deposits $ 101,255 $ 172 0.68% $ 159,353 $ 1,096 2.76%
Savings deposits 2,680,407 9,567 1.43 1,882,379 9,705 2.07
Time deposits 3,322,421 35,995 4.35 3,276,652 46,469 5.69
---------- -------- ---------- --------
Total interest-bearing deposits 6,104,083 45,734 3.01 5,318,384 57,270 4.32
Short-term borrowings 662,410 3,061 1.85 679,431 7,157 4.23
Trust preferred securities 108,600 2,127 7.86 108,600 2,615 9.66
Debt and FHLB advances 1,063,265 16,143 6.09 925,653 14,275 6.19
---------- -------- ---------- --------
Total interest-bearing liabilities 7,938,358 67,065 3.39 7,032,068 81,317 4.64
-------- --------
Non-interest-bearing liabilities 931,675 844,555
Shareholders' equity 690,822 628,047
---------- ----------
Total liabilities and equity $9,560,855 $8,504,670
========== ==========
Net interest income, fully
taxable equivalent and
Net interest spread $ 88,210 3.55% $ 80,614 3.50%
======== ========
Net interest income, fully
taxable equivalent to
earning assets 3.94% 4.05%
Provision for Credit Losses
The provision for credit losses represents the charge to income necessary to
adjust the allowance for loan losses to an amount that represents management's
assessment of the estimated probable credit losses inherent in
19
Sky Financial's loan portfolio which have been incurred at each balance sheet
date. The provision for credit losses increased $876 or 10.2% to $9,444 in the
second quarter of 2002 compared to $8,568 in the second quarter of 2001. The
higher provision for credit losses in the second quarter of 2002 was
attributable to growth in the loan portfolio and higher net charge-offs. Net
charge-offs were $6,721 or 0.40% (annualized) of average loans during the three
months ended June 30, 2002, compared to $5,930 or 0.39% (annualized) for the
same period in 2001.
June 30, December 31, June 30,
2002 2001 2001
- ----------------------------------------------------------------
Allowance for credit losses
as a percentage of loans 1.58% 1.60% 1.58%
Allowance for credit losses
as a percentage of
non-performing loans 177.98 303.55 376.50
Allowance for credit losses as a percentage of non-performing loans for the
second quarter of 2002 decreased compared to the second quarter of 2001 as a
result of the transfer of four related loans aggregating $22.8 million to
non-accrual status. See section titled "Non-Performing Assets" of management's
discussion and analysis for further information.
Non-Interest Income
Non-interest income was $35,196 for the second quarter increasing 16.0% from
$30,348 in the same period last year. Brokerage and insurance commissions were
$9,554 for the quarter up $4,301, or 81.9% from the prior year. The increases
reflect the acquisitions of two insurance agencies in 2002, Value Added Benefits
in April and Celaris Group in January. Service charges on deposits were $8,379,
up $751, or 9.8% from last year, attributable mainly to the strong growth in
deposits from last year. Mortgage banking revenues were $4,497 for the second
quarter, down $1,557, or 25.7% from the second quarter last year due to a
comparative decrease in mortgage refinancing activity. Other non-interest income
was $8,262 for the three months ended June 30, 2002, up 14.4% as compared to the
same period of the previous year, due mainly to increased income from investment
partnerships.
Non-Interest Expense
On a reported basis, non-interest expense for the second quarter was $70,143,
which included $5,652 of non-recurring expenses mainly related to the
implementation of Sky's new technology platform. Excluding non-recurring
charges, non-interest expense for the second quarter was $64,491 compared to
$58,160 in the second quarter last year. The increase in the second quarter was
due primarily to the increase in salary and other employee costs as a result of
both the acquisition of two insurance agencies during 2002 and the acquisition
of ten banking centers during the fourth quarter of 2001. The efficiency ratio
was 52.26% for the second quarter of 2002, compared to 52.41% for the same
quarter last year.
Income Taxes
The provision for income taxes for the second quarter of 2002 decreased $69 to
$14,064 from $14,133 for the same period in 2001. The effective tax rate for the
three months ended June 30, 2002 32.7% as compared to 32.6% for the same period
in 2001.
20
Six Months Ended June 30, 2002 and 2001
Results of Operations
Operating earnings, which exclude non-recurring items, were $64,059 for the six
months ended June 30, 2002, an increase of $6,402 compared to $57,657 for the
same period in 2001. Diluted operating earnings per common share for the six
months ended June 30, 2002 was $.77 ($.78 basic), as compared to $.69 ($.70
basic) for the same period in 2001. On an operating basis, return on average
equity (ROE) and return on average assets (ROA) were 18.95% and 1.37%,
respectively, for the second quarter of 2002 compared to 18.73% and 1.38%,
respectively, in 2001.
On a reported basis, net income was $60,385 for the six months ended June 30,
2002, an increase $2,316 compared to $58,069 for the same period in 2001. During
the six months ended June 2002, Sky Financial recorded $3,673 in after-tax
non-recurring expenses related to Sky's implementation of a new technology
platform company-wide. In addition, results for the six months ended June 30,
2001 include the sale of the Company's independent broker/dealer business
realizing an after-tax non-recurring gain of $412. For the first six months of
2002, ROE and ROA were 17.86% and 1.29%, respectively, on a reported basis
compared to 18.86% and 1.39%, respectively, for the same period in 2001. Diluted
earnings per common share for the six months ended June 30, 2002 was $.73 ($.73
basic), as compared to $.70 ($.70 basic) for the six months ended June 30, 2001.
Business Line Results
Sky Financial's business line results for the six months ended June 30, 2002 and
2001 are summarized in the table below.
Net Income (Loss)
Six Months Ended June 30, 2002 2001
- -------------------------------------------------------------------
Community Banking $ 62,798 $ 61,704
Financial Service Affiliates 2,242 1,885
Sky Financial Solutions, Inc. (3,024) (4,452)
Parent and Other (1,631) (1,068)
-------- --------
Consolidated Total $ 60,385 $ 58,069
======== ========
The community banking net income increased for the six months ended June 30,
2002 as compared with earnings for the same period in 2001. This was primarily
due to increased net interest income, service charges on deposits and gains on
securities available for sale, offset by decreases in mortgage banking income
and a higher provision for loan loss during the first six months of the year. In
addition, the community banking's net income was lowered by the merger of the
Company's technology services affiliate into its community banking operations,
resulting in higher employee costs offset by lower equipment costs. The
community banking efficiency ratio was 47.2% for the six months ended June 30,
2002 compared to 46.0% for the same period in 2001. The 2002 community banking
results reflect a ROE of 19.54% and a ROA of 1.44% compared to 21.61% and 1.54%,
respectively, for the same period in 2001.
21
Sky Financial Solutions' loss decreased for the six months ended 2002 as
compared to the same period in 2001 due to increased interest income as a result
of the continued growth in its retained loan portfolio. During the six months
ended June 30, 2002, Sky Financial Solutions added $120 million in new loans to
its portfolio.
The financial service affiliates' net income increased as compared to 2001 as a
result of the acquisition of two insurance companies during the year, offsetting
a decline in net income at the company's trust operations.
Parent and other includes the net funding costs of the parent company and all
significant non-recurring items of income and expense. The results for the six
months ended June 30, 2002 include after-tax non-recurring charges of $3,673
related to Sky's implementation of a new technology platform.
Net Interest Income
Net interest income for the six months ended June 30, 2002 was $171,329, an
increase of $14,807 or 9.5% from $156,522 for the six months ended June 30,
2001. Net interest income, the difference between interest income earned on
interest-earning assets and interest expense incurred on interest-bearing
liabilities, is the most significant component of the Company's earnings. Net
interest income is affected by changes in the volumes, rates and composition of
interest-earning assets and interest-bearing liabilities. Average earning assets
at June 30, 2002 increased 12.5% as compared to June 30, 2001, with continued
strong growth in average loans, increasing 10.6% from last year, due in part to
average loan growth at SFS of $234,920 at June 30, 2002 as compared to June 30,
2001. Average deposits increased 14.5% from this time last year, which included
organic growth of 9.7% and the October 2001 acquisition of ten branches with
$289 million in deposits. Sky Financial's net interest margin for the six months
ended June 30, 2002 was 3.95%, a decrease of 9 basis points from the same period
a year ago. The net interest rate margin was positively impacted by $859 of net
interest earned from interest rate swaps on the Company's trust preferred
securities, but was ultimately lower during the second quarter of 2002 as
compared to the same period in 2001 due to the initial lower spread earned on
the branch deposits acquired in the fourth quarter of last year.
22
The following table reflects the components of Sky Financial's net interest
income for the six months ended June 30, 2002 and 2001. Rates are computed on a
tax equivalent basis and non-accrual loans have been included in the average
balances.
SKY FINANCIAL GROUP, INC.
Average Balance Sheets and Net Interest Margins
(Dollars in thousands) Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
- --------------------------------------------------------------------------------------------------
Average Average
Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------
Interest-earning assets
Interest-earning deposits $ 36,142 $ 322 1.67% $ 14,943 $ 529 7.14%
Federal funds sold and other 12,093 93 1.71 27,625 751 5.48
Securities 2,158,061 62,188 5.81 1,822,712 60,103 6.65
Loans 6,637,938 245,140 7.42 6,035,079 264,164 8.83
---------- -------- ---------- --------
Total interest-earning assets 8,844,234 307,743 7.00 7,900,359 325,547 8.31
--------
Non-earning assets 580,245 535,423
---------- ----------
Total assets $9,424,479 $8,435,782
========== ==========
Interest-bearing liabilities
Demand deposits $ 103,781 $ 419 0.81% $ 150,005 $ 2,024 2.72
Savings deposits 2,578,837 18,768 1.47 1,869,335 21,888 2.36
Time deposits 3,317,617 72,898 4.43 3,242,654 93,633 5.82
---------- -------- ---------- --------
Total interest-bearing deposits 6,000,235 92,085 3.09 5,261,994 117,545 4.50
Short-term borrowings 686,652 6,375 1.87 688,348 15,817 4.63
Trust preferred securities 108,275 4,508 8.40 108,600 5,201 9.66
Debt and FHLB advances 1,065,588 31,719 5.94 903,379 28,686 6.40
---------- -------- ---------- --------
Total interest-bearing liabilities 7,860,750 134,687 3.46 6,962,321 167,249 4.84
--------
Non-interest-bearing liabilities 881,863 852,720
Shareholders' equity 681,866 620,741
---------- ----------
Total liabilities and equity $9,424,479 $8,435,782
========== ==========
Net interest income, fully
taxable equivalent and
Net interest spread $173,056 3.56% $158,298 3.47%
======== ========
Net interest income, fully
taxable equivalent to
earning assets 3.95% 4.04%
Provision for Credit Losses
The provision for credit losses represents the charge to income necessary to
adjust the allowance for loan losses to an amount that represents management's
assessment of the estimated probable credit losses inherent in Sky Financial's
loan portfolio which have been incurred at each balance sheet date. The
provision for credit losses increased $3,541 or 23% to $18,765 in the six months
ended June 30, 2002 compared to $15,224 for the same period in 2001. The higher
provision for credit losses for the six months ended June 30, 2002 was
attributable to growth in the loan portfolio and higher net charge-offs. Net
charge-offs were $14,223 or 0.43% (annualized) of average loans during the six
months ended June 30, 2002, compared to $10,189 or 0.34% (annualized) for the
same period in 2001.
Non-Interest Income
Non-interest income was $68,019 for the six months ended June 30, 2002, up from
$62,519 in the same period last year. Brokerage and insurance commissions were
$18,286 for the first six months of 2002, up $4,259, or 30.4% from the prior
year. The increases reflect the acquisitions of two insurance agencies in 2002,
Value Added Benefits in April and Celaris Group in January. Service charges on
deposits were $15,989, up $1,452, or 10% from
23
last year, attributable mainly to the strong growth in deposits from last year.
Mortgage banking revenues were $9,950 for the six months ended June 30, 2002,
down $756, or 7.1% from the same period last year due to a comparative decrease
in mortgage refinancing activity. Other non-interest income was $15,332 for the
six months ended June 30, 2002, up 6.3% as compared to $14,426 during the same
period of the previous year, due mainly to increased income from investment
partnerships. Other non-interest income for the six months ended June 30, 2001
also included the sale of the Company's independent broker/dealer business
realizing an after-tax non-recurring gain of $412.
Non-Interest Expense
On a reported basis, non-interest expense for the six months ended June 30, 2002
was $130,674, which included $5,652 of non-recurring expenses mainly related to
the implementation of Sky's new technology platform. Excluding non-recurring
charges, non-interest expense for the six months ended June 30, 2002 was
$125,022 an increase of $7,623 as compared to $117,399 for the same period in
the previous year and is due primarily increases in salary and other employee
costs as a result of both the acquisition of two insurance agencies during 2002
and the acquisition of ten banking centers during the fourth quarter of 2001.
The efficiency ratio was 51.86% for the six months ended June 30, 2002, compared
to 53.32% for the same period last year.
Income Taxes
The provision for income taxes for the six months ended June 30, 2002 increased
$1,175 to $29,524 from $28,349 for the same period in 2001. The effective tax
rate for the three months ended June 30, 2002 was 32.8%, unchanged as compared
to the same period in 2001.
Balance Sheet
At June 30, 2002, total assets were $9,728,347, an increase of $508,119 from
December 31, 2001. The increase was primarily attributable to increases in loans
of $385,294, securities available for sale of $191,497 and other assets of
$66,602. The increases were partially offset by a reduction in cash and interest
earning deposits of $48,837, a decrease in loans held for sale of $73,826, a
decrease in federal funds sold of $8,000 and an increase in allowance for credit
losses of $4,542. The net growth in assets was funded primarily by growth in
total deposits, up $326,058, and an increase in borrowed funds of $125,825.
Shareholders' equity totaled $699,343 at June 30, 2002, increasing $50,899 from
December 31, 2001. Net retained earnings (net income less cash dividends) for
the six months ended June 30, 2002 totaled $29,011. Other comprehensive income
increased by $15,452, primarily due to an increase in the market value of
securities available for sale. Additionally, treasury stock decreased $5,166 due
to an increase in stock option exercises, offset by continued repurchasing of
shares by Sky Financial, as authorized by its Board of Directors (see Condensed
Consolidated Statement of Changes in Shareholders' Equity and Note 8).
Non-Performing Assets
The following table presents the aggregate amounts of non-performing assets and
respective ratios on the dates indicated.
24
June 30, December 31, June 30,
2002 2001 2001
- -------------------------------------------------------------------
Non-accrual loans $56,876 $33,319 $25,029
Restructured loans 3,840 785 1,079
------- ------- -------
Total non-performing loans 60,716 34,104 26,108
Other real estate owned 4,179 2,467 2,367
------- ------- -------
Total non-performing assets $64,895 $36,571 $28,475
======= ======= =======
Loans 90 days or more past due
and not on non-accrual $ 9,200 $15,902 $ 8,582
Non-performing loans to
total loans 0.89% 0.53% 0.42%
Non-performing assets to
total loans plus other
real estate owned 0.95 0.56 0.46
Allowance for credit losses to
total non-performing loans 177.98 303.55 376.50
Loans 90 days or more past due
and not on non-accrual to
total loans 0.13 0.25 0.14
Performing loans where some concerns exist as to the ability of the borrower to
comply with present loan repayment terms, excluding non-performing loans,
approximated $46,760 and $45,616 at June 30, 2002 and December 31, 2001,
respectively, and are being closely monitored by management and the Boards of
Directors of the subsidiaries. The classification of these loans, however, does
not imply that management expects losses on each of these loans, but believes
that a higher level of scrutiny is prudent under the circumstances. These loans
require close monitoring despite the fact that they are currently performing.
Such classifications relate to specific concerns relating to each individual
borrower and do not relate to any concentrated risk elements common to all loans
in this group.
Non-accrual loans increased from $33,319 at December 31, 2001 to $56,876 million
at June 30, 2002 primarily as a result of the addition of $22.8 million of loans
that are secured by pools of commercial leases for which payment is over 90 days
past due. These loans are guaranteed by surety bonds or insurance policies
issued by three creditworthy insurance companies. Sky is engaged in litigation
with these insurance companies to enforce their payment obligations, as are a
number of other banks nationwide. After consultation with its counsel as to the
strength of its position, Sky believes that the credits are well secured and the
prospects for recovery of all principal and interest are good.
As of June 30, 2002, Sky Financial did not have any loan concentrations which
exceeded 10% of total loans.
Allowance for Credit Losses
The following table presents a summary of Sky Financial's credit loss experience
for the six months ended June 30, 2002 and 2001.
25
Six Months Ended
June 30,
2002 2001
- --------------------------------------------------------------------------------
Balance of allowance at beginning of year $103,523 $ 93,261
Loans charged-off:
Real estate (4,037) (853)
Commercial and agricultural (3,283) (5,797)
Installment and credit card (9,897) (6,916)
Other loans (541) --
-------- --------
Total loans charged-off (17,758) (13,566)
-------- --------
Recoveries:
Real estate 338 300
Commercial and agricultural 463 1,013
Installment and credit card 2,734 2,032
Other loans -- 32
-------- --------
Total recoveries 3,535 3,377
-------- --------
Net loans charged-off (14,223) (10,189)
Provision charged to operating expense 18,765 15,224
-------- --------
Balance of allowance at end of period $108,065 $ 98,296
======== ========
Ratio of net charge-offs to
average loans outstanding 0.43% 0.34%
Allowance for credit losses
to total loans 1.58 1.58
Allowance for credit losses
to total non-performing loans 177.98 376.50
Sky Financial maintains an allowance for credit losses at a level adequate to
absorb management's estimate of probable losses inherent in the loan portfolio.
The allowance is comprised of a general allowance, a specific allowance for
identified problem loans and an unallocated allowance.
The general allowance is determined by applying estimated loss factors to the
credit exposures from outstanding loans. For construction, commercial and
commercial real estate loans, loss factors are applied based on internal risk
grades of these loans. For residential real estate, installment, credit card and
other loans, loss factors are applied on a portfolio basis. Loss factors are
based on peer and industry loss data compared to Sky Financial's historical loss
experience, and are reviewed for revision on a quarterly basis, along with other
factors affecting the collectibility of the loan portfolio.
Specific allowances are established for all criticized and classified loans,
where management has determined that, due to identified significant conditions,
the probability that a loss has been incurred exceeds the general allowance loss
factor determination for those loans.
The unallocated allowance recognizes the estimation risk associated with the
allocated general and specific allowances and incorporates management's
evaluation of existing conditions that are not included in the allocated
allowance determinations. These conditions are reviewed quarterly by management
and include general economic conditions, credit quality trends, and internal
loan review and regulatory examination findings.
26
The following table sets forth Sky Financial's allocation of the allowance for
credit losses as of June 30, 2002 and December 31, 2001.
June 30, 2002 December 31, 2001
- ---------------------------------------------------------------
Construction $ 2,277 $ 2,387
Real estate 29,562 29,332
Commercial, financial
and agricultural 42,654 33,468
Installment and credit card 24,226 25,756
Other loans 14 1,099
Unallocated 9,332 11,481
-------- --------
Total $108,065 $103,523
======== ========
Liquidity
Management of liquidity is of growing importance to the banking industry. The
liquidity of a financial institution reflects its ability to meet loan requests,
to accommodate possible outflows in deposits and to take advantage of interest
rate market opportunities. The ability of a financial institution to meet its
current financial obligations is a function of balance sheet structure, the
ability to liquidate assets, and the availability of alternative sources of
funds.
In addition to maintaining a stable core deposit base, Sky Financial's banking
subsidiary maintains adequate liquidity primarily through the use of investment
securities and unused borrowing capacity. At June 30, 2002, securities and other
short term investments with maturities of one year or less totaled $18,978. In
addition, the mortgage-backed securities provide an estimated cash flow of
approximately $385,595 over a twelve-month timeframe. The banking subsidiary is
a member of the Federal Home Loan Bank (FHLB). The FHLB provides a reliable
source of funds over and above retail deposits. As of June 30, 2002, the banking
subsidiary had total credit availability with the FHLB of $703,256, of which
$579,388 was outstanding.
On March 6, 2002, Sky Financial renegotiated an agreement with unrelated
financial institutions which enabled Sky Financial to borrow up to $120,000
through March 5, 2003. At June 30, 2002, Sky Financial had borrowings of $93,000
under this agreement.
Sky Financial, through SFS, entered into a conduit warehousing facility with a
financial institution to provide up to $125,000 of interim funding for loans
originated by SFS. At June 30, 2002, the was no outstanding balance under the
warehouse line of credit. SFS has outstanding term funding of $429,485 at June
30, 2002 through the issuance of collateralized notes in a private placement.
This amount includes term funding of $150,760 that was completed in May 2002
through the issuance of collateralized notes in a private placement in the 144A
market.
Since Sky Financial is a holding company and does not conduct operations, its
primary sources of liquidity are borrowings from outside sources and dividends
paid to it by its banking subsidiary. For the banking subsidiary, regulatory
approval is required in order to pay dividends in excess of the subsidiary's
earnings retained for the current year plus retained net profits for the prior
two years. As a result of these restrictions,
27
dividends that could be paid to Sky Financial by its bank subsidiary, without
prior regulatory approval, were limited to $11,818 at June 30, 2002.
Asset/Liability Management
Closely related to liquidity management is the management of interest-earning
assets and interest-bearing liabilities. Sky Financial manages its rate
sensitivity position to avoid wide swings in net interest margins and to
minimize risk due to changes in interest rates. At June 30, 2002, Sky
Financial's gap position, the difference between the dollar value of interest
rate sensitive assets and interest rate sensitive liabilities, was slightly
negative for six months and one year and therefore does not expect to experience
any significant fluctuations in its net interest income as a consequence of
changes in interest rates. See also Item. 3, "Quantitative and Qualitative
Disclosures About Market Risk."
Forward-Looking Statements
This report includes forward-looking statements by Sky Financial relating to
such matters as anticipated operating results, credit quality expectations,
prospects for new lines of business, technological developments, economic trends
(including interest rates), acquisition and reorganization transactions and
similar matters. Such statements are based upon the current beliefs and
expectations of Sky Financial's management and are subject to risks and
uncertainties. While Sky Financial believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could prove to be inaccurate, and accordingly, actual results and
experience could differ materially from the anticipated results or other
expectations expressed by Sky Financial in its forward-looking statements.
Factors that could cause actual results or experience to differ from results
discussed in the forward-looking statements include, but are not limited to:
economic conditions; volatility and direction of market interest rates; capital
investment in and operating results of non-banking business ventures of Sky
Financial; governmental legislation and regulation; material unforeseen changes
in the financial condition or results of operations of Sky Financial's
customers; customer reaction to and unforeseen complications with respect to Sky
Financial's restructuring or integration of acquisitions; difficulties in
realizing expected cost savings from acquisitions; difficulties associated with
data conversions in acquisitions or migrations to a single platform system; and
other risks identified from time-to-time in Sky Financial's other public
documents on file with the Securities and Exchange Commission. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements, and the purpose of this paragraph is to secure the
use of the safe harbor provisions.
Sarbanes - Oxley Act of 2002
On July 30, 2002, President Bush signed into law the Sarbanes - Oxley Act of
2002, which contains important new requirements for public companies in the area
of financial disclosure and corporate governance. Although much of the act is
still being assessed, we do not anticipate any significant changes in the
operations of and reporting by the Company as a result of the Act. In accordance
with the requirements of the Sarbanes - Oxley Act, written certifications for
this quarterly report on Form 10-Q by the chief executive officer and chief
financial officer accompany this report as filed with the SEC.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk that a financial institution's earnings and capital, or
its ability to meet its business objectives, will be adversely affected by
movements in market rates or prices such as interest rates, foreign exchange
rates, equity prices, credit spreads and/or commodity prices. Within Sky
Financial, the dominant market risk exposure is changes in interest rates. The
negative effects of this exposure is felt through the net interest
28
margin, mortgage banking revenues and the market value of various assets and
liabilities.
Sky Financial manages market risk through its Asset/Liability Committee (ALCO)
at the consolidated level. This committee monitors interest rate risk through
sensitivity analysis, whereby it measures potential changes in future earnings
and the fair market values of financial instruments that may result from one or
more hypothetical changes in interest rates. This analysis is performed by
estimating the expected cash flows of Sky Financial's financial instruments
using interest rates in effect at June 30, 2002 and December 31, 2001. For the
fair value estimates, the cash flows are then discounted to year end to arrive
at an estimated present value of Sky Financial's financial instruments.
Hypothetical changes in interest rates are then applied to the financial
instruments, and the cash flows and fair values are again estimated using these
hypothetical rates. For the net interest income estimates, the hypothetical
rates are applied to the financial instruments based on the assumed cash flows.
Sky Financial applied these interest rate shocks to its financial instruments up
200 basis points and up and down 100 basis points. Down 200 basis points was not
measured due to the low probability of such a decline.
The following table presents the potential ratio of Sky Financial's interest
rate sensitive assets (i.e. assets that will mature or reprice within a specific
time period) divided by its interest rate sensitive liabilities (i.e.
liabilities that will mature or reprice within a specific time period), commonly
referred to as the "interest rate sensitivity gap" or "gap", over a six month
time period and a twelve month time period.
June 30, ALCO Guidelines
2002 Max Min
- -----------------------------------------
Six Month 99.5% 125% 95%
Twelve Month 99.5% 125% 95%
Sky Financial also utilizes interest rate swaps to effectively move its
liability interest rate re-pricing down the yield curve to more effectively
match the re-pricing characteristics of its assets.
The following table presents an analysis of the potential sensitivity of Sky
Financial's annual net interest income to sudden and sustained 200 basis-point
changes in market rates.
June 30, December 31,
2002 2001 Guidelines
- ------------------------------------------------------------
One Year Net Interest
Income Change
+200 Basis points (4.3)% (.2)% (10.0)%
+100 Basis points (1.4) (.03) (5.0)%
-100 Basis points (2.7) (.27) (5.0%)
The projected volatility of net interest income and the net present value of
equity rates to a + 200 basis points change and +/- 100 basis point change at
June 30, 2002 and December 31, 2001 fall within the ALCO guidelines.
At June 30, 2002, a 200 basis point increase in the market rates would impact
the Company's economic value of equity by (5.7)%. A 100 basis point increase
29
and decrease in market rates would impact the Company's economic value of equity
by (1.2)% and (4.6)%, respectively.
The preceding analysis is based on numerous assumptions, including relative
levels of market interest rates, loan prepayments and reactions of depositors to
changes in interest rates, and should not be relied upon as being indicative of
actual results. Further, the analysis does not necessarily contemplate all
actions Sky Financial may undertake in response to changes in interest rates.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Between August 2000 and December 2001, Sky Bank provided financing to a
commercial borrower and its affiliated entities for the purchase of three
separate portfolios of commercial lease pools and a warehouse line of credit to
finance lease pools. These loans, totaling $30 million with a current
outstanding balance of $22.8 million, are secured by assignments of the payment
streams from the underlying leases, surety bonds, and a limited guarantee from
the sole member of the commercial borrower. Sky Bank, in addition to numerous
other financial institutions, has been named in two separate lawsuits filed by
Illinois Union Insurance Company ("IU") in Federal District Court, District of
Nevada and RLI Insurance Company ("RLI") in Federal District Court, Southern
District of California. Both IU and RLI are seeking to rescind surety bonds or
collateral security insurance policies that were assigned to Sky Bank by the
borrower as credit enhancements for lease pools. The surety companies allege
that the originator of the lease fraudulently induced the insurers to issue the
surety bonds, and that the bonds are therefore void.
Sky Financial has made demand for payment from IU, RLI and a third surety, Royal
Indemnity Insurance Company ("Royal") under the relevant bonds and insurance
policies. IU, RLI and Royal (the "Sureties") have failed to make the payments
required under the surety bonds and insurance policies. As a result, on April
11, 2002, Sky Financial filed suit against each of the Sureties in the Court of
Common Pleas, Cuyahoga County, Ohio, which were subsequently removed to Federal
District Court, Northeastern District of Ohio, Eastern Division. Sky Financial's
complaints claim breach of contract, bad faith and allege that the Sureties are
liable for the payments due to Sky under the terms of the bonds and are estopped
from asserting fraud as a defense to paying any claims under the bonds.
RLI and IU have filed motions to transfer the cases to federal court in San
Diego and Las Vegas, respectively.
Sky Financial has reviewed the relevant matters of fact and law with special
counsel and believes that it has substantial and meritorious claims against the
Sureties, due in part to the fact that under the terms of the bonds, the
Sureties undertake the responsibility for all credit and fraud underwriting, and
waive all defenses associated with the bonds, including defenses of fraud. Sky
Financial has and will continue to vigorously exercise all the rights and
remedies available to it to obtain payment under the bonds.
While the ultimate outcome of the matter cannot be determined at this time, Sky
Financial management does not believe that the outcome of any of these
30
pending legal proceedings will materially affect the consolidated financial
position of Sky Financial.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Shareholders of Sky Financial Group, Inc. held April
17, 2002, ballot totals for the election of five (5) Class I Directors to serve
a three-year term until the Annual Meeting of Shareholders in 2005 were as
follows:
Class I Directors
Term Expires 2005 FOR WITHHELD
- -------------------------------------------
Marty E. Adams 65,896,411 916,434
Jonathon A. Levy 65,858,936 953,909
Thomas J. O'Shane 65,627,378 1,185,467
Edward J. Reiter 65,992,354 820,494
C.Gregory Spangler 65,728,840 1,084,005
Total shares voted were 66,812,845 or 81.04% of the outstanding shares.
The following incumbent Class II and Class III Directors who were not nominees
for election at the April 17, 2002 Annual Meeting were as follows:
Gregory N. Chandler II James C. McBane
Robert C. Duvall Gregory L. Ridler
D. James Hilliker Emerson J. Ross, Jr.
Richard R. Hollington, Jr. Robert E. Spitler
Fred H. Johnson III Joseph N. Tosh II
Gerard P. Mastroianni
At the Annual Meeting of Sky Financial Group, Inc. Shareholders on April 17,
2002, ballot totals for the approval and adoption of the 2002 Stock Option and
Stock Appreciation Rights Plan were as follows:
FOR 47,828,659
AGAINST 6,442,595
ABSTAIN 1,064,355
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31
(11.1) Statement Re Computation of Earnings Per Common Share
(b) Reports on Form 8-K
Sky Financial filed a report on Form 8-K with the Securities and
Exchange Commission as of May 7, 2002, announcing that it had entered
into an Agreement and Plan of Merger with Three Rivers Bancorp, Inc.
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 hereunto duly authorized.
SKY FINANCIAL GROUP, INC.
/s/ Kevin T. Thompson
- ------------------------------
Kevin T. Thompson
Executive Vice President / Chief Financial Officer
DATE: August 14, 2002
SKY FINANCIAL GROUP, INC.
32
EXHIBIT INDEX
Exhibit No. Description Page Number
(11.1) Statement Re Computation of Earnings
Per Common Share
The information required by this exhibit is incorporated
herein by reference from the information contained in Note 7
"Earnings Per Share" on page 11 of Sky Financial's Form 10-Q
for June 30, 2002.
33