Second Bancorp Incorporated Amended 10-Q for 6/30
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Second Bancorp Incorporated and Subsidiary
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements (unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Qualitative and Quantitative Disclosure About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings —
Item 2. Changes in Securities —
Item 3. Defaults upon Senior Securities — Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders —
Item 5. Other Information — Not Applicable
Item 6. Exhibits and Reports on Form 8-K:
SIGNATURES
Exhibit 11

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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q/A

     
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001
OR
 
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period ______ to ______

Commission file number: 0-15624

 
SECOND BANCORP INCORPORATED
(exact name of registrant as specified in its charter)
     
Ohio 34-1547453
(State or other jurisdiction of
incorporation or organization)		 (I.R.S. Employer
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 — 10,033,510 shares outstanding as of July 31, 2001.

Explanatory Note: We are amending our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2001 to include in Part I, Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operation additional information regarding changes in financial condition from December 31, 2000 to June 30, 2001 and additional information regarding changes in results of operations with respect to the most recent fiscal year-to-date periods of June 30, 2001 and June 30, 2000.

 

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SECOND BANCORP INCORPORATED AND SUBSIDIARY

         
INDEX Page
Number
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
 
Consolidated balance sheets —
June 30, 2001 and 2000 and December 31, 2000		 3
 
Consolidated statements of income —
Three and six months ended June 30, 2001 and 2000		 4
 
Consolidated statements of comprehensive income —
Three and six months ended June 30, 2001 and 2000		 5
 
Consolidated statements of shareholders’ equity —
Six months ended June 30, 2001 and 2000		 6
 
Consolidated statements of cash flows —
Six months ended June 30, 2001 and 2000		 7
 
Notes to consolidated financial statements — June 30, 2001 8-9
 
Item 2. Management’s Discussion and Analysis of
      Financial Condition and Results of Operations		 10-13
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk 14
         
PART II. OTHER INFORMATION
 
     Item 1. Legal Proceedings 15
 
     Item 2. Changes in Securities 15
 
     Item 3. Defaults upon Senior Securities 15
 
     Item 4. Submission of Matters to a Vote of Security Holders 15
 
     Item 5. Other Information 15
 
     Item 6. Exhibits and Reports on Form 8-K 15
         
     SIGNATURES 16
 
     Statement 11 Re: Computation of Earnings Per Share 17

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements


Second Bancorp Incorporated and Subsidiary
Consolidated Balance Sheets

                               
June 30 December 31 June 30
(Dollars in thousands) 2001 2000 2000
ASSETS
Cash and due from banks $ 36,024 $ 35,272 $ 38,526
Federal funds sold and temporary investments 27,979 0 0
Securities:
Available-for-sale (at market value) 380,262 382,098 370,250
Trading account (at market value) 0 328 944
Total securities: 380,262 382,426 371,194
Loans 1,075,039 1,070,089 1,157,123
Less reserve for loan losses 15,609 15,217 11,378
Net loans 1,059,430 1,054,872 1,145,745
Premises and equipment 17,122 18,039 18,119
Accrued interest receivable 9,759 11,181 10,508
Goodwill and intangible assets 7,547 6,038 5,472
Other assets 40,247 38,462 43,349
Total assets $ 1,578,370 $ 1,546,290 $ 1,632,913
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Demand — non-interest bearing $ 109,477 $ 110,045 $ 115,380
Demand — interest bearing 90,077 87,268 88,184
Savings 234,314 246,056 269,925
Time deposits 625,890 592,766 631,960
Total deposits 1,059,758 1,036,135 1,105,449
Federal funds purchased and securities sold under agreements to repurchase 117,275 129,895 124,930
Note payable 1,000 1,000 0
Other borrowed funds 4,981 2,163 2,609
Federal Home Loan Bank advances 261,447 251,733 276,009
Accrued expenses and other liabilities 10,802 8,167 8,548
Total liabilities 1,455,263 1,429,093 1,517,545
Shareholders’ equity:
Common stock, no par value; 30,000,000 shares authorized; 10,802,510; 10,787,310 and 10,776,870 shares issued, respectively 37,166 36,935 36,974
Treasury stock; 785,000, 730,200 and 575,720 shares, respectively (14,740 ) (13,947 ) (11,646 )
Other comprehensive income (loss) 1,810 281 (8,631 )
Retained earnings 98,871 93,928 98,671
Total shareholders’ equity 123,107 117,197 115,368
     Total liabilities and shareholders’ equity $ 1,578,370 $ 1,546,290 $ 1,632,913

See notes to consolidated financial statements.

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Second Bancorp Incorporated and Subsidiary

Consolidated Statements of Income
                                       
For the Three Months For the Six Months
(Dollars in thousands, Ended June 30 Ended June 30
except per share data) 2001 2000 2001 2000
INTEREST INCOME
Loans (including fees):
Taxable $ 21,751 $ 22,887 $ 43,852 $ 44,423
Exempt from federal income taxes 279 238 567 453
Securities:
Taxable 5,302 5,261 10,427 9,970
Exempt from federal income taxes 775 777 1,548 1,659
Federal funds sold and other 298 16 489 109
Total interest income 28,405 29,179 56,883 56,614
INTEREST EXPENSE
Deposits 11,192 11,312 22,661 22,191
Federal funds purchased and securities sold under agreements to repurchase 1,053 1,356 2,240 2,540
Note payable 16 0 34 19
Other borrowed funds 15 58 52 101
Federal Home Loan Bank advances 3,831 3,808 7,682 6,700
Total interest expense 16,107 16,534 32,669 31,551
Net interest income 12,298 12,645 24,214 25,063
Provision for loan losses 1,342 696 2,103 1,383
Net interest income after provision for loan losses 10,956 11,949 22,111 23,680
NON-INTEREST INCOME
Service charges on deposit accounts 1,273 1,079 2,534 2,133
Trust fees 749 1,049 1,505 2,053
Gain on sale of loans 1,106 309 1,889 700
Trading account gain (loss) 13 (431 ) 71 (317 )
Security (loss) gain (12 ) 206 517 305
Other operating income 1,502 1,234 2,674 2,375
Total non-interest income 4,631 3,446 9,190 7,249
NON-INTEREST EXPENSE
Salaries and employee benefits 5,096 5,189 10,290 10,505
Net occupancy 1,062 1,037 2,178 2,089
Equipment 921 959 1,970 1,946
Professional services 397 698 740 1,175
Assessment on deposits and other taxes 405 425 806 838
Amortization of goodwill and other intangibles 80 115 161 231
Other operating expenses 1,844 2,008 3,711 3,944
Total non-interest expense 9,805 10,431 19,856 20,728
Income before federal income taxes 5,782 4,964 11,445 10,201
Income tax expense 1,524 1,251 2,999 2,552
Net income before cumulative effect of accounting change $ 4,258 $ 3,713 $ 8,446 $ 7,649
Cumulative effect of accounting change, net of
tax — FAS133		 0 0 (101 ) 0
Net income $ 4,258 $ 3,713 $ 8,345 $ 7,649
NET INCOME PER COMMON SHARE:
Basic — before cumulative effect of
accounting change		 $ 0.42 $ 0.36 $ 0.84 $ 0.74
Diluted — before cumulative effect of
accounting change		 $ 0.42 $ 0.36 $ 0.84 $ 0.74
Basic $ 0.42 $ 0.36 $ 0.83 $ 0.74
Diluted $ 0.42 $ 0.36 $ 0.83 $ 0.74
Weighted average common shares outstanding:
Basic 10,007,904 10,318,828 10,013,966 10,362,424
Diluted 10,103,060 10,340,082 10,079,973 10,396,194

See notes to consolidated financial statements.

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Second Bancorp Incorporated and Subsidiary

Consolidated Statements of Comprehensive Income
                                 
For the Three Months For the Six Months
(Dollars in thousands, Ended June 30 Ended June 30
except per share data) 2001 2000 2001 2000
Net income $ 4,258 $ 3,713 $ 8,345 $ 7,649
 
Other comprehensive income, net of tax:
 
Change in other comprehensive income — SFAS 133 (490 ) — — —
 
Change in other comprehensive income — deferred
compensation plan		 (71 ) — (71 ) —
 
Change in unrealized market value adjustment
on securities available-for-sale		 (1,069 ) (34 ) 1,600 (840 )
 
Total other comprehensive (loss) income (1,630 ) (34 ) 1,529 (840 )
 
Comprehensive income $ 2,628 $ 3,679 $ 9,874 $ 6,809

See notes to consolidated financial statements.

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Second Bancorp Incorporated and Subsidiary

Consolidated Statements of Shareholders’ Equity
                                         
Accumulated
Other
Common Treasury Comprehensive Retained
(Dollars in thousands) Stock Stock Income Earnings Total
Balance, January 1, 2000 $ 36,966 $ (7,140 ) $ (7,791 ) $ 94,312 $ 116,347
 
Net income 7,649 7,649
 
Change in unrealized market value adjustment
on securities available-for-sale, net of tax of $452		 (840 ) (840 )
 
Cash dividends declared: common ($.32 per share) (3,290 ) (3,290 )
 
Purchase of treasury shares (4,506 ) (4,506 )
 
Common stock issued — dividend reinvestment plan 8 8
Balance, June 30, 2000 $ 36,974 $ (11,646 ) $ (8,631 ) $ 98,671 $ 115,368
 
Balance, January 1, 2001 $ 36,935 $ (13,947 ) $ 281 $ 93,928 $ 117,197
 
Net income 8,345 8,345
 
Change in other comprehensive income —
deferred compensation plan, net of tax of $38		 (71 ) (71 )
 
Change in unrealized market value adjustment
on securities available-for-sale, net of tax of $862		 1,600 1,600
 
Cash dividends declared: common ($.34 per share) (3,402 ) (3,402 )
 
Purchase of treasury shares (793 ) (793 )
 
Common stock issued —
stock options and dividend reinvestment plan		 231 231
Balance, June 30, 2001 $ 37,166 $ (14,740 ) $ 1,810 $ 98,871 $ 123,107

See notes to consolidated financial statements.

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Consolidated Statements of Cash Flows
Second Bancorp Incorporated and Subsidiary

                               
For the Six Months Ended
(Dollars in thousands) June 30 June 30
Operating Activities 2001 2000
Net income $ 8,345 $ 7,649
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 2,103 1,383
Provision for depreciation 1,665 1,721
Provision for amortization of intangibles 161 231
Provision for allowance of mortgage servicing rights 30 0
Net (increase) / amortization of servicing rights (1,700 ) 228
(Accretion) amortization of investment discount and premium (143 ) 133
Deferred income taxes (60 ) 138
Securities gains (517 ) (305 )
Other gains, net (1,890 ) (704 )
Net decrease (increase) in trading account securities 328 (944 )
Decrease (increase) in interest receivable 1,422 (1,231 )
(Decrease) increase in interest payable (33 ) 265
Originations of loans held-for-sale (175,077 ) (29,535 )
Proceeds from sale of loans held-for-sale 176,966 30,238
Net change in other assets & other liabilities 14 (1,371 )
Net cash provided by operating activities 11,614 7,896
Investing Activities
Proceeds from maturities of securities — available-for-sale 50,896 15,311
Proceeds from sales of securities — available-for-sale 63,067 44,497
Purchases of securities — available-for-sale (109,009 ) (63,590 )
Net increase in loans (6,661 ) (86,634 )
Net increase in premises and equipment (747 ) (1,265 )
Net cash used by investing activities (2,454 ) (91,681 )
Financing Activities
Net (decrease) increase in demand deposits, interest bearing demand and savings deposits (9,501 ) 1,564
Net increase in time deposits 33,124 6,296
Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase (12,620 ) 18,398
Decrease in note payable 0 (4,000 )
Net increase (decrease) in borrowings 2,818 (3,130 )
Net advances from Federal Home Loan Bank 9,714 75,733
Cash dividends (3,402 ) (3,290 )
Purchase of treasury stock (793 ) (4,506 )
Issuance of common stock 231 8
Net cash provided by financing activities 19,571 87,073
Increase in cash and cash equivalents 28,731 3,288
Cash and cash equivalents at beginning of year 35,272 35,238
Cash and cash equivalents at end of period $ 64,003 $ 38,526
   
Supplementary Cash Flow Information:
Cash paid for 1) Federal Income taxes — $3,025 and $2,552 for the six months ended
June 30, 2001 and 2000, respectively and 2) Interest — $32,679 and $31,667
for the six months ended June 30, 2001 and 2000, respectively.

See notes to consolidated financial statements.

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Notes to Consolidated Financial Statements (unaudited)
Second Bancorp Incorporated and Subsidiary
June 30, 2001
(Dollars in thousands)

NOTE 1 — BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2001 are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. Certain reclassifications have been made to amounts previously reported in order to conform to current period presentations. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.

NOTE 2 — COMPREHENSIVE INCOME
During the first six months of 2001 and 2000, total comprehensive income amounted to $9,874 and $6,809, respectively. The components of comprehensive income, net of tax, for the six month periods ended June 30, 2001 and 2000 are as follows:

                 
2001 2000
Net income $ 8,345 $ 7,649
Change in other comprehensive income — deferred compensation plan (71 ) 0
Unrealized gains (losses) on available-for-sale securities 1,600 (840 )
Comprehensive income $ 9,874 $ 6,809

Accumulated other comprehensive income, net of related tax, at June 30, 2001 totaled $1,810 and was comprised of accumulated changes in unrealized market value adjustments on securities available-for-sale, net of tax and deferred supplemental income, net of tax. Accumulated other comprehensive income and loss, net of related tax, at December 31, 2000 and June 30, 2000 totaled $281 and $(8,631), respectively, and was comprised entirely of accumulated changes in unrealized market value adjustments on securities available-for-sale, net of tax. Disclosure of reclassification amounts:

                 
Six Months Ended
June 30, 2001 June 30, 2000
Unrealized holding gains (losses) arising during the period $ 2,117 $ (535 )
Less: reclassification of gains included in net income (517 ) (305 )
Net unrealized gains (losses) on available-for-sale securities $ 1,600 $ (840 )

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NOTE 3 — RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activity” as amended in June 1999 by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities — Deferral of the Effective Date of FASB Statement No. 133,” and in June 2000, by SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities, “ (collectively SFAS No. 133). SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge. The accounting for changes in the fair value of derivative (gains and losses) depends on the intended use of the derivative and resulting designation. On January 1, 2001, the Corporation adopted SFAS No. 133 resulting in a cumulative effect of accounting change transition adjustment of $(101), after tax. The impact on 2001 operating results is not considered to be material.

In June 2001, the FASB issued SFAS No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill [and intangible assets deemed to have indefinite lives] will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives.

The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement to existing of goodwill and indefinite lived intangible assets is expected to result in an increase in net income of $103 ($.01 per share) per year. During 2002, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company.

NOTE 4 — ACQUISITION OF COMMERCE EXCHANGE CORPORATION
On July 23, 2001 the Company announced an agreement to acquire Commerce Exchange Corporation located in Beachwood, Ohio. The all-cash transaction is structured as a purchase for accounting purposes and, excluding transaction costs, is expected to be modestly accretive to earnings per share in the first year. The transaction is expected to close in the fourth quarter of 2001 and is subject to approval by Commerce’s shareholders and appropriate regulatory agencies. Upon completion of the merger, Commerce Exchange Corporation’s subsidiary, Commerce Exchange Bank, in expected to merge into Second National Bank. The two offices in Beachwood and North Olmstead, Ohio will be operated as Second National retail banking centers.

Under the agreement, Commerce’s shareholders will receive cash in an aggregate amount of $26.5 million subject to adjustments tied to, among other things, Commerce’s net retained earnings for the period through completion of the transaction.

The cash required to fund the pending acquisition is expected to be provided through the issuance of $26 to $30 million in trust preferred securities. The remaining net proceeds, if any, will be used to make payments on outstanding debt or for general corporate purposes.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General
Second Bancorp Incorporated is a one-bank holding company headquartered in Warren, Ohio. Our bank, The Second National Bank of Warren, was originally established in 1880. Operating through 34 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.

Forward-looking statements
The sections that follow contain certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the expectations discussed in these forward-looking statements.

Financial Condition
At June 30, 2001, the Company had consolidated total assets of $1.58 billion, deposits of $1.06 billion and shareholders’ equity of $123 million. Since June 30, 2000, total assets have decreased by $55 million or 3.4%, primarily as a result of the sale of $130 million in residential mortgage loans during the third quarter of 2000. The sale resulted in a decline in total assets and lower exposure to long-term fixed rate assets. Gross loans have decreased during the past year by $82 million to $1.075 billion as of June 30, 2001. Consumer lending activities have resulted in a strong increase in outstanding consumer loan balances, while the sale of the residential mortgage loans has resulted in a reduction of total residential mortgage loans from a 43% concentration of total loans as of June 30, 2000 to 30% at the most recent quarter end. Consumer loans represented 30% of loans at the end of the first quarter of 2001 versus 22% for the first quarter of 2000. Cash, federal funds sold and other liquid assets increased by $25 million during the past 12 months as a result of the reduction in total loans.

Deposits decreased by $46 million since June 30, 2000 primarily through decreases in savings account balances. Core funding, which includes DDA, NOW and savings accounts, decreased by $40 million since June 30, 2000, partially due to transfers of Private Banking account balances to off-balance sheet products. Federal Home Loan Bank advances have decreased by $15 million since a year ago.

Since December 31, 2000, total assets have increased by an annualized rate of 4%, primarily through an increase in liquid assets. Deposits have increased by $23.6 million and now total $1.06 billion. The increase in deposits was attributable to an increase in short-term time deposits totaling $33 million during the period. The short-term funding was acquired to meet anticipated loan demand. Gross loan growth has been nominal since the end of last year, increasing by $5 million over the period.

Results of Operations
Quarterly Comparison

The Company reported net operating income of $4,258,000 for the second quarter of 2001. Net income for the second quarter represented forty-two cents ($.42) per share on a diluted basis. Operating return on average assets (ROA) and return on average total shareholders’ equity (ROE) were 1.08% and 13.98%, respectively, for the second quarter of 2001 compared to 0.93% and 13.01% for last year’s second quarter. A strong increase in non-interest income and a 6% reduction in expenses helped increase net income and offset a slight decline in the net interest margin and an increase of $646,000 in provision for loan losses from the second quarter of 2000.

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      Commercial Lending. Commercial lending activities focus primarily on providing local independent commercial and professional firms with commercial business loans and loans secured by owner-occupied real estate. We primarily make secured and unsecured commercial loans for general business purposes, including working capital, accounts receivable financing, machinery and equipment acquisition, and commercial real estate financing. These loans have both fixed and floating interest rates and typically have maturities of three to seven years. To a lesser extent, we also make construction loans and finance commercial equipment leases. Commercial loans comprised approximately 40% of our total loan portfolio at June 30, 2001.

      Retail Lending. The Company offers a full range of retail loans to individuals, including the owners and principals of our commercial customers and a wide range of retail customers in our market area. We offer consumer loans for a variety of personal financial needs, including home equity, new and used automobiles, boat loans, credit cards and overdraft protection for checking account customers. At June 30, 2001, approximately 50% of our consumer loans consisted of indirect auto loans. Our indirect auto loans are originated through new car dealers in the local area. Consumer loans comprised approximately 30% of our total loan portfolio at June 30, 2001.

      Trust. The trust department is a traditional provider of fiduciary services with a focus on administration of estates, trusts and qualified employee benefit plans. During 2000, personal trust accounts and employee benefit accounts produced approximately 75% and 25% of the total revenues of the department, respectively. The anticipated addition in the third quarter 2001 of a daily valuation service for 401(k) plans is expected to position us well for future growth in employee benefit assets and revenues. Fee income is down 28.5% from the second quarter of 2000 due to the reduction in the amount of assets under management caused by the loss of over $150 million in accounts and the decline in overall equity values over the period. Our trust department had approximately $670 million in assets under management at June 30, 2001.

      Mortgage Banking. Our mortgage department underwrites and originates a wide range of retail mortgage loan products and sells a significant volume of them primarily on a servicing retained basis. Generally, the loans sold into the secondary mortgage market make funds available for reuse in mortgage or other lending activities. The sales generate a net gain (including origination fee income and deferred origination costs), limit the interest rate risk caused by holding long-term, fixed-rate loans, and build a portfolio of serviced loans which generate a recurring stream of fee income. We sold approximately $175 million of loans through the first half of 2001 and serviced $565 million in mortgage loans for others at June 30, 2001.

      Asset Quality. The reserve for loan losses represented 1.45% of loans as of June 30, 2001. The determination of the reserve for loan losses is based on Management’s evaluation of the potential losses in the loan portfolio at June 30, 2001 considering, among other relevant factors, repayment status, borrowers’ ability to repay, collateral and current economic conditions. The methodology for the provision for loan losses includes analysis of various economic factors including loan losses and portfolio growth. The provision for loan losses increased to $1,342,000 for the second quarter of 2001 from $696,000 during the same period in 2000. The increase is due to an increase in consumer charge-offs, which elevated total charge-offs to $1,511,000 during the second quarter of 2001 versus $673,000 during the second quarter of 2000. Loan losses are expected to remain slightly above their historical level of .25% to .30% of loans for the remainder of the year. The reserve was 0.98% of total loans at June 30, 2000. Non-accrual loans have increased over the past year and total $4,666,000 as of June 30, 2001 versus $2,987,000 as of the same date last year. Similarly, loans past due over 90 days and still accruing totaled $5,415,000 as of June 30, 2001 versus $2,875,000 as of the same date last year, reflecting the general economic slowdown in both the national and local economies.

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Net Interest Income. Net interest income for the second quarter of 2001 decreased by $347,000 from the same period last year to $12,298,000. The decrease was due to a slightly lower net interest margin that is being influenced by a decline in low-cost core deposits and an increase in higher cost large time deposits as well as a $21 million reduction in average interest-earning assets. The net interest margin declined to 3.47% for the second quarter of 2001 versus 3.51% for the same period in 2000. The reduction in average interest earning assets during the past 12 months was strongly influenced by the sale of mortgage loans in the third quarter of 2000.

Non-interest Income. Non-interest income (excluding security gains and losses and trading activity) totaled $4,630,000, or 26% higher than the second quarter of 2000. The increase came from a variety of sources including: 1) an increase in 18% in service charges on deposit accounts attributable to a revised deposit account structure, fee schedule, collection procedures and an increase in the number of accounts, 2) an increase in the gain on sale of loans from $309,000 to $1,106,000 primarily due to lower mortgage rates and the resulting increase in refinancing activity. Trust income is down 28.5% from the second quarter of 2000 due to the reduction in the amount of assets under management caused by the loss of over $150 million in accounts and the decline in overall equity values over the period.

Non-interest Expense. Expenses for the second quarter of 2001 were 6% lower than for the same period in 2000. Reductions were realized in all expense categories except occupancy from a year ago. The Company expects to continue to focus on cost controls and reductions in the coming quarters.

Year-to-date Comparison:
The Company reported net income of $8,345,000 ($0.83 per diluted share) for the first six months of 2001. Income before cumulative effect of accounting change (“operating net income”) was $8,446,000 ($0.84 per diluted share), or 10.4% greater than the net income reported for the same period in 2000. The following ratio discussion references operating net income for 2001. Return on average assets (ROA) and return on average total shareholders’ equity (ROE) were 1.08% and 14.03%, respectively, for the first six months of 2001 compared to 0.97% and 13.36% for the same period last year. A strong increase in non-interest income and a 4% reduction in expenses helped increase net income and offset a slight decline in the net interest margin and an increase of $720,000 in provision for loan losses from the first half of 2000.

Asset Quality. The provision for loan losses increased to $2,103,000 for the first six months of 2001 from $1,383,000 during the same period in 2000. The increase is due to an increase in consumer charge-offs, which elevated total charge-offs to $1,511,000 during the second quarter of 2001 versus $673,000 during the second quarter of 2000. Loan losses are expected to remain slightly above their historical level of .25% to .30% of loans for the remainder of the year.

Net Interest Income. Net interest income for the first half of 2001 decreased by $849,000 from the same period last year to $24,214,000. The decrease was due to a slightly lower net interest margin that is being influenced by a decline in low-cost core deposits and an increase in higher cost large time deposits as well as a $5 million reduction in average interest-earning assets. The net interest margin declined to 3.45% for the first six months of 2001 versus 3.56% for the same period in 2000. The reduction in average interest earning assets was strongly influenced by the sale of mortgage loans in the third quarter of 2000.

Non-interest Income. Non-interest income (excluding security gains and losses and trading activity) totaled $8,602,000, or 18.5% higher than the first half of 2000. The increase came from a variety of sources including: 1) an increase of 19% in service charges on deposit accounts attributable to a revised deposit account structure, fee schedule, collection procedures and an increase in the number of accounts and 2) an increase in the gain on sale of loans from $700,000 to $1,889,000 primarily due to lower mortgage rates and the resulting increase in refinancing activity. Trust income is down 26.7% from the first half of 2000 due to the reduction in the amount of assets under management caused by the loss of over $150 million in accounts and the decline in overall equity values over the period. Security gains for the first six months of 2001 totaled $517,000 versus $305,000 for the same period in 2000. The proceeds from the sale of securities in 2001 were reinvested in higher yielding securities which is expected to improve future income streams.

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Non-interest Expense. Expenses for the first half of 2001 were 4% lower than for the same period in 2000. Reductions were realized in all expense categories except equipment and occupancy, which were 4% and 1% greater, respectively. The Company expects to continue to focus on cost controls and reductions in the coming quarters.

Capital resources. Shareholders’ equity has increased by $8 million since June 30, 2000 due primarily to the increase in accumulated other comprehensive income (“OCI”), which increased by nearly $11 million since a year earlier. Since December 31, 2000, shareholders’ equity has increased by $6 million, primarily through an increase in retained earnings. The company repurchased 54,800 shares of common stock into Treasury during 2001, all in the first quarter, which partially offset the increase in OCI. The Company has slightly more than 65,000 shares remaining under the present repurchase authorization. Repurchases under this authorization are expected to be completed through open market transactions at prevailing market prices and are discretionary, based upon management’s periodic assessment of market conditions and financial benefit to the Company. This continuing repurchase authorization will remain in effect until amended or withdrawn by subsequent board action. As of June 30, 2001, the Company had repurchased 785,000 of the authorized shares of common stock.

Liquidity. Management of the Company’s liquidity position is necessary to ensure that funds are available to meet the cash flow needs of depositors and borrowers as well as the operating cash needs of the Company. Funds are available from a number of sources including maturing securities, payments made on loans, the acquisition of new deposits, the sale of packaged loans, borrowing from the FHLB and overnight lines of credit of over $37 million through correspondent banks. The parent company has three major sources of funding including dividends from the Bank, $20 million in unsecured lines of credit with correspondent banks, which are renewable annually, and access to the capital markets. One million of the unsecured line of credit is in use as of June 30, 2001.

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Item 3. Qualitative and Quantitative Disclosure About Market Risk

Forward-looking statements
The section that follows contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the expectations discussed in these forward-looking statements.

Market Risk Management:
Market risk is the risk of economic loss from adverse changes in the fair value of financial instruments due to changes in (a) interest rates, (b) foreign exchange rates, or (c) other factors that relate to market volatility of the rate, index, or price underlying the financial instrument. The Company’s market risk is composed primarily of interest rate risk. The Company’s Asset/Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit the exposure to interest rate risk. Since nearly the Company’s entire interest rate risk exposure relates to the financial instrument activity of the Bank, the Bank’s Board of Directors review the policies and guidelines established by ALCO.

The primary objective of asset/liability management is to provide an optimum and stable net interest margin, after-tax return on assets and return on equity capital, as well as adequate liquidity and capital. Interest rate risk is monitored through the use of two complementary measures: dynamic gap analysis and earnings simulation models. While each of the measurement techniques has limitations, taken together they represent a reasonably comprehensive tool for measuring the magnitude of interest rate risk inherent in the Company.

The earnings simulation model forecasts earnings for a one-year horizon frame under a variety of interest rate scenarios; including interest rate shocks, stepped rates and yield curve shifts. Management evaluates the impact of the various rate simulations against earnings in a stable interest rate environment. The most recent model projects net income would decrease by 1.3% if interest rates would immediately rise by 200 basis points. It projects a decrease in net income of 2.5% if interest rates would immediately fall by 200 basis points. Management believes this reflects an acceptable level of risk from interest rate movements. The earnings simulation model includes assumptions about how the various components of the balance sheet and rate structure are likely to react through time in different interest rate environments. These assumptions are derived from historical analysis and management’s outlook. Management expects interest rates to have a neutral to downward bias for the remainder of 2001.

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 uses off-balance sheet swaps, caps and floors to manage interest rate risk.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings —

The Company is subject to various pending and threatened lawsuits in the ordinary course of business in which claims for monetary damages are asserted. While any litigation involves an element of uncertainty, in the opinion of management, liabilities, if any, arising from such litigation or threat thereof will not have a material impact on the financial position or results of operations of the Company.

Item 2. Changes in Securities — On July 30, 2001, the Company issued and sold 10,000 common shares to an executive officer of the Company pursuant to the exercise of stock options issued to him under the Company’s 1998 Non-Qualified Stock Option Plan (the “1998 Plan”). The exercise price per share was $13.657, for an aggregate exercise price of $136,570. The executive officer immediately resold the common shares into the open market. Although the Company had not filed a Registration Statement on Form S-8 with respect to the 1998 Plan at the time of sale, the Company filed the registration statement on August 22, 2001.

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 May 8, 2001. The results of the votes on the matters presented to shareholders were included in the Form 10-Q for the period ended March 31, 2001.

Item 5. Other Information — Not Applicable

Item 6. Exhibits and Reports on Form 8-K:

The following exhibits are included herein:
Exhibit (11) Statement re: computation of earnings per share

The Company filed a report on Form 8-K on April 25, 2001 to announce earnings for the first quarter of 2001. The Company filed a report on Form 8-K on May 11, 2001 to announce the election of Rick L. Blossom as Chairman of Second Bancorp Incorporated and The Second National Bank of Warren. The Company filed a report on Form 8-K on July 26, 2001 to announce earnings for the second quarter of 2001. The Company filed a second report on Form 8-K on July 26, 2001 to announce the pending acquisition of Commerce Exchange Corporation. (See Note 4 of the Notes to Consolidated Financial Statements for more information regarding the acquisition).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

SECOND BANCORP INCORPORATED

     
Date: August 29, 2001 /s/ David L. Kellerman
David L. Kellerman, Treasurer

 

Signing on behalf of the registrant and as principal accounting officer and principal financial officer.

 

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