U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20459
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarter Ended: Commission File No.:
September 30, 2001 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
Virginia 54-1779978
------------------------------- -----------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
37 East Main Street
Warrenton, Virginia 20186
--------------------------------------- ----------
(address of principal executive office) (Zip Code)
Registrant's Telephone Number, including area code: (540) 349-3900
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
------ -----
As of November 2, 2001, there were 3,897,962 shares of the registrant's Common
Stock outstanding.
SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
September 30, 2001
TABLE OF CONTENTS
-----------------
Page
Number
------
PART I. FINANCIAL INFORMATION
- ------- ---------------------
Item 1. Financial Statements
Consolidated Balance Sheets
as of September 30, 2001 (Unaudited) and
December 31, 2000 3
Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2001 and 2000
(Unaudited) 4
Consolidated Statements of Comprehensive Income
for the Three and Nine Months Ended September 30, 2001 and
2000 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000
(Unaudited) 6
Notes to Consolidated Financial Statements
(Unaudited) 7 - 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 - 18
PART II. OTHER INFORMATION
- ------- -----------------
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
PART III. SIGNATURES 20
- --------- ----------
2
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
September 30,
2001 December 31,
(Unaudited) 2000
-------------- -------------
Assets
Cash and due from banks $ 21,944,077 $ 22,036,524
Overnight earning deposits 6,065,887 2,479,728
Investment securities - available for sale 338,404,292 233,407,038
Loans held for sale 777,500 220,000
Loans receivable, net 343,977,207 313,770,584
Cash surrender value of life insurance 15,915,487 15,217,987
Bank premises & equipment, net 6,969,385 6,687,190
Other assets 15,379,729 16,117,035
-------------- -------------
Total assets $ 749,433,564 $ 609,936,086
============== =============
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 623,061,053 $ 515,111,665
Advances from Federal Home Loan Bank - short term 40,500,000 19,000,000
Advances from Federal Home Loan Bank - long term 15,000,000 15,000,000
Company-obligated mandatorily redeemable securities
of subsidiary holding solely parent debentures 13,000,000 13,000,000
Other liabilities 10,298,395 8,135,260
-------------- -------------
Total liabilities 701,859,448 570,246,925
-------------- -------------
Commitments
Stockholders' equity
Preferred stock 136 136
Common stock 30,285 30,147
Capital in excess of par 28,921,090 28,713,010
Retained earnings 15,651,465 10,709,742
Accumulated other comprehensive income 2,971,140 236,126
-------------- -------------
Total stockholders' equity 47,574,116 39,689,161
-------------- -------------
Total liabilities and stockholders' equity $ 749,433,564 $ 609,936,086
============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
3
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
----------- ----------- ------------ ------------
Interest income:
Loans $ 7,750,290 $ 6,430,924 $ 23,195,325 $ 17,963,012
Investment securities 6,537,908 3,054,114 16,546,311 8,129,600
----------- ----------- ------------ ------------
Total interest income 14,288,198 9,485,038 39,741,636 26,092,612
----------- ----------- ------------ ------------
Interest expense:
Deposits 5,430,455 4,503,384 16,808,565 11,845,413
Borrowings 1,609,473 509,827 4,255,045 1,175,473
----------- ----------- ------------ ------------
Total interest expense 7,039,928 5,013,211 21,063,610 13,020,886
----------- ----------- ------------ ------------
Net interest income 7,248,270 4,471,827 18,678,026 13,071,726
Provision for loan losses 1,150,000 300,000 2,420,000 975,000
----------- ----------- ------------ ------------
Net interest income after provision for loan losses 6,098,270 4,171,827 16,258,026 12,096,726
----------- ----------- ------------ ------------
Other income:
Fee income 764,676 727,054 2,347,119 2,009,655
Gain on sale of loans 110,400 361,583 512,723 966,176
Gain on investment securities, net 362,879 - 1,513,670 -
Other 275,245 37,830 822,769 128,242
----------- ----------- ------------ ------------
Total other income 1,513,200 1,126,467 5,196,281 3,104,073
----------- ----------- ------------ ------------
Other expense:
Employee compensation and benefits 2,098,105 1,767,370 6,402,549 5,117,262
Premises and equipment 780,298 643,409 2,196,796 1,881,839
Data processing expense 359,040 293,705 1,066,155 840,526
Advertising 91,026 41,426 213,001 151,060
Deposit insurance expense 25,659 20,335 71,445 56,695
Other 918,091 619,791 2,711,049 1,588,070
----------- ----------- ------------ ------------
Total other expense 4,272,219 3,386,036 12,660,995 9,635,452
----------- ----------- ------------ ------------
Income before income taxes 3,339,251 1,912,258 8,793,312 5,565,347
Provision for income taxes 1,061,900 624,600 2,760,500 1,829,200
----------- ----------- ------------ ------------
Net income $ 2,277,351 $ 1,287,658 $ 6,032,812 $ 3,736,147
=========== =========== ============ ============
Earnings per common share:
Basic $ 0.75 $ 0.46 $ 2.00 $ 1.38
Diluted 0.72 0.45 1.93 1.36
Dividends declared per common share 0.12 0.12 0.36 0.36
Weighted average shares outstanding:
Basic 3,027,744 2,784,913 3,019,124 2,703,467
Diluted 3,179,696 2,833,403 3,129,212 2,756,126
The accompanying notes are an integral part of these consolidated financial
statements
4
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
----------- ----------- ----------- -----------
Net income $ 2,277,351 $ 1,287,658 $ 6,032,812 $ 3,736,147
Other comprehensive income:
Cash flow hedge:
Unrealized holding loss (1,009,688) (242,798) (1,406,253) (73,493)
Reclassification adjustment for net
gains (losses) included in net income 125,084 (119,148) 151,063 (226,308)
Available-for-sale securities:
Unrealized holding gain 4,018,804 594,074 6,912,821 455,865
Reclassification adjustment for net gains
included in net income (362,879) (29,210) (1,513,670) (29,210)
----------- ----------- ----------- -----------
Other comprehensive income before tax 2,771,321 202,918 4,143,961 126,854
Income tax expense related to items of other
comprehensive income 942,249 68,993 1,408,947 43,131
----------- ----------- ----------- -----------
Other comprehensive income, net of tax 1,829,072 133,925 2,735,014 83,723
Comprehensive income $ 4,106,423 $ 1,421,583 $ 8,767,826 $ 3,819,870
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements
5
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
----------------------------
2001 2000
------------ ------------
Cash flows from operating activities:
Net Income $ 6,032,812 $ 3,736,147
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 342,440 747,780
Provision for loan losses 2,420,000 975,000
Gain on sale of loans (512,723) (966,176)
Gain on sale of securities (1,513,670) (29,210)
Amortization of deferred loan fees (611,724) (383,995)
Loans originated - held for sale (6,791,176) (4,120,025)
Loans sold - held for sale 6,338,370 4,698,156
Increase in other assets (875,155) (1,587,080)
Increase (decrease) in other liabilities 2,358,993 (86,908)
------------ ------------
Net cash provided by operating activities 7,188,167 2,983,689
------------ ------------
Cash flows from investing activities:
Increase in loans receivable (31,122,728) (16,629,545)
Purchase of investment securities, held-to-maturity - (7,776,346)
Purchase of investment securities, available-for-sale (388,132,566) (59,717,283)
Sale of investment securities, available-for-sale 143,841,541 3,000,000
Paydowns of investment securities 146,225,458 14,119,823
Cash acquired from merger - 2,827,432
Increase in premises and equipment, net (1,100,877) (440,674)
Increase in other equity securities (1,684,654) (33,500)
------------ ------------
Net cash used in investing activities (131,973,826) (64,650,093)
------------ ------------
Cash flows from financing activities:
Net increase in deposits 107,662,241 31,283,757
Increase in advances from FHLB - short term 21,500,000 14,139,249
Proceeds from Capital Trust borrowings - 13,000,000
Proceeds from issuance of common stock 208,219 54,377
Repurchase of common stock - (506,654)
Dividends on preferred and common stock (1,091,089) (965,990)
------------ ------------
Net cash provided by financing activities 128,279,371 57,004,739
------------ ------------
Net increase (decrease) in cash and cash equivalents 3,493,712 (4,661,665)
Cash and cash equivalents, beginning of period 24,516,252 23,330,266
------------ ------------
Cash and cash equivalents, end of period $ 28,009,964 $ 18,668,601
============ ============
SUPPLEMENTAL DATA
Cash payments for interest on deposits and borrowings $ 5,644,813 $ 3,920,118
------------ ------------
Cash payments for income taxes $ 3,125,000 $ 1,250,000
------------ ------------
The accompanying notes are an integral part of these consolidated financial
statements
6
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q, and, therefore, do
not include all information or footnotes necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
accounting principles generally accepted in the United States of America.
However, all adjustments which are, in the opinion of management, necessary for
a fair presentation have been included. All adjustments are of a normal
recurring nature. The results of operations for the three and nine-month periods
ended September 30, 2001 are not necessarily indicative of the results of the
full year. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes included in
Southern Financial Bancorp, Inc.'s ("Southern Financial") Annual Report and Form
10K for the year ended December 31, 2000.
NOTE 2 - INVESTMENT SECURITIES
The following table sets forth the investment securities portfolio as of
the dates indicated:
September 30, 2001 December 31, 2000
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
------------- ------------- ------------- -------------
Available-for-sale securities:
Mortgage-backed securities $ 56,652,718 $ 57,498,966 $ 112,535,562 $ 113,242,566
Collaterized mortgage obligations 239,334,721 243,650,273 95,666,261 95,764,697
Obligations of counties and municipalities 861,072 879,820 6,202,386 6,117,481
Corporate obligations 30,747,667 30,353,893 12,729,995 12,415,779
U.S. Treasury and agency securities 931,873 952,311 2,449,319 2,482,140
Federal Home Loan Bank stock 3,775,000 3,775,000 2,700,000 2,700,000
Federal Reserve Bank stock 809,950 809,950 615,000 615,000
Other equity securities 484,079 484,079 69,375 69,375
------------- ------------- ------------- -------------
Total classified as investment securities 333,597,080 338,404,292 232,967,898 233,407,038
Corporate obligations classified as loans 37,992,373 38,354,452 32,837,067 32,418,054
------------- ------------- ------------- -------------
$ 371,589,453 $ 376,758,744 $ 265,804,965 $ 265,825,092
============= ============= ============= =============
In December 2000, investment securities classified as held-to-maturity were
transferred to the available-for-sale classification in order to provide more
flexibility in managing the interest-rate risk in the investment security
portfolio. Because of the transfer, Southern Financial will be unable to
classify investment securities as held-to-maturity in the foreseeable future.
NOTE 3 - HEDGE ACCOUNTING
As part of its interest rate risk management, Southern Financial makes
extensive use of interest rate swaps. Some of them are accounted for as cash
flow and some are fair value hedges in accordance with SFAS 133. Cash flow
hedges are used to hedge variable interest rate assets or liabilities and fair
value hedges are used to hedge fixed rate assets or liabilities.
Southern Financial uses interest rate swaps that are accounted for as cash
flow hedges to hedge the issuance of pools of certificates of deposit (CD's)
which reprice with changes in market interest rates. Under the terms of these
interest rate swaps, Southern Financial is the fixed rate payer and the floating
rate receiver. The floating rate on the interest rate swaps is tied to three-
month LIBOR, which approximates the issuance rate on the pool of CD's. The
combination of the swaps and the issuance of the pool of CD's operates to
produce long-term rate deposits.
7
Southern Financial also uses interest rate swaps that are accounted for as
fair value hedges to hedge the issuance of individual fixed rate CD's. Under
the terms of these interest rate swaps, Southern Financial is the fixed rate
receiver and the floating rate payer. The floating rate on the interest rate
swaps is generally tied to three-month LIBOR, which approximates the issuance
rate on the individual CD's. The combination of the swaps and the issuance of
individual CD's operates to produce long-term floating rate deposits. The terms
of the CD's and the interest rate swaps mirror each other and were committed
simultaneously.
During the quarter ended September 30, 2001, Southern Financial entered
into interest rate swap agreements totaling $45 million in connection with
issuance of like amounts of its certificates of deposit. These interest rate
swap agreements are accounted for as fair value hedges. Changes in the fair
value of the fair value hedges are accounted for in the income statement, as are
changes in the fair value of the certificates of deposit. During the quarter
ended September 30, 2001, three interest rate swaps with a notional amount of
$30 million were terminated with no resulting gain or loss. Changes in the
inherent value portion of the fair value of cash flow hedges are accounted for
in other comprehensive income. The interest rate swaps outstanding as of
September 30, 2001, are presented in the following table:
9/30/01 12/31/00 Pay Receive
Notional Estimated Estimated Maturity Call Fixed Floating
amount fair value fair value date date rate rate
----------------------------------------------------------------------------------------------------
Cash flow hedges: $ 5,000,000 $ (245,684) $ 84,924 1/8/04 None 5.27% 3 month LIBOR
5,000,000 (231,312) 81,214 1/15/04 None 5.29% 3 month LIBOR
5,000,000 (221,332) 88,379 1/29/04 None 5.23% 3 month LIBOR
5,000,000 (215,964) 171,115 2/2/09 None 5.45% 3 month LIBOR
-----------------------------------------
20,000,000 (914,292) 425,632
-----------------------------------------
9/30/01 12/31/00 Rec. Pay
Notional Estimated Estimated Maturity Call Fixed Floating
amount fair value fair value date date rate rate
------------------------------------------------------------------------------------------------------------
Fair value hedges: 10,000,000 266,156 40,416 10/26/07 10/26/01 7.25% 3 month LIBOR less 4 basis points
10,000,000 59,984 48,906 11/30/07 11/30/01 7.00% 3 month LIBOR less 5 basis points
10,000,000 94,280 1,961 12/28/10 12/28/01 7.00% 3 month LIBOR
10,000,000 62,066 - 2/22/08 2/22/02 6.00% 3 month LIBOR less 1 basis point
10,000,000 14,857 - 3/7/11 3/7/02 6.25% 3 month LIBOR less 2 basis points
10,000,000 107,945 - 12/26/08 6/26/02 6.00% 3 month LIBOR plus 1.5 basis points
10,000,000 39,394 - 6/28/11 6/28/02 6.25% 3 month LIBOR
10,000,000 89,482 - 7/26/11 7/26/02 6.50% 3 month LIBOR plus 1 basis point
10,000,000 161,146 - 2/27/04 None 4.50% 3 month LIBOR plus 2 basis points
10,000,000 93,010 - 8/28/09 8/28/02 6.00% 3 month LIBOR plus 2 basis points
10,000,000 93,046 - 3/12/07 9/12/02 5.00% 3 month LIBOR plus 2 basis points
5,000,000 68275 - 9/19/16 9/19/04 6.50% 3 month LIBOR plus 2 basis points
-------------------------------------------
115,000,000 1,149,641 91,283
-------------------------------------------
Total $135,000,000 $ 235,349 $ 516,915
===========================================
8
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
September 30, December 31,
2001 2000
------------ ------------
Mortgage:
Residential $ 44,397,497 $ 53,164,832
Nonresidential 153,813,561 130,270,765
Construction:
Residential 13,424,313 17,815,735
Nonresidential 14,401,885 10,491,442
Non-Mortgage:
Business 119,131,669 101,002,182
Consumer 6,668,458 7,617,423
------------ ------------
Total loans receivable 351,837,383 320,362,379
Less:
Deferred loan fees, net 1,891,424 1,670,453
Allowance for loan losses 5,968,752 4,921,342
------------ ------------
Loans receivable, net $343,977,207 $313,770,584
============ ============
Corporate obligations classified as loans are included in non-mortgage
business loans in the table above.
The following sets forth information regarding the allowance for loan
losses:
Nine Months Nine Months
Ended Ended
9/30/01 9/30/00
----------- -----------
Allowance at beginning of period $ 4,921,342 $ 3,452,131
Acquired from First Savings - 594,233
Provision for losses charged to income 2,420,000 975,000
Charge-offs (1,651,931) (527,222)
Recoveries 279,341 280,741
----------- -----------
Allowance at end of period $ 5,968,752 $ 4,774,883
=========== ===========
9
The following table sets forth information regarding past due and
nonperforming assets as of the periods indicated:
At September 30, At December 31,
2001 2000
-------------- --------------
Accruing Loans 90 Days
or More Delinquent
Nonresidential $ - $ -
Business - 673
Consumer - 8,563
------------ -------------
Total - 9,236
============ =============
Nonperforming Loans
Residential 335,456 555,248
Nonresidential 1,201,244 1,316,975
Business - -
------------ -------------
Subtotal 1,536,700 1,872,223
------------ -------------
Real Estate Owned:
Residential - 16,900
------------ -------------
Total Nonperforming Assets $ 1,536,700 $ 1,889,123
============ =============
Nonperforming Assets
to Total Assets 0.21% 0.31%
============ =============
10
NOTE 5 - EARNINGS PER SHARE
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number of shares
of potential dilutive common stock. Income attributable to preferred stock was
$2,963 for the quarter ended September 30, 2001 and for the quarter ended
September 30, 2000. Income attributable to preferred stock was $8,889 for the
nine months ended September 30, 2001 and for the nine months ended September 30,
2000.
For the three months ended For the nine months ended
September 30, 2001 September 30, 2000 September 30, 2001 September 30, 2000
--------------------- ---------------------- -------------------- --------------------
Per Per Per Per
Share Share Share Share
Shares Amount Shares Amount Shares Amount Shares Amount
----------- ------- --------- ------ --------- ------ --------- ------
Basic earnings per share 3,027,744 $0.75 2,784,913 $0.46 3,019,124 $2.00 2,703,467 $1.38
======= ======= ====== ======
Effect of dilutive securities:
Stock options 129,977 26,515 88,112 30,684
Convertible preferred stock 21,975 21,975 21,975 21,975
----------- --------- --------- ---------
Diluted earnings per share 3,179,696 $0.72 2,833,403 $0.45 3,129,211 $1.93 2,756,126 $1.36
=========== ======= ========= ======= ========= ====== ========= ======
NOTE 6 - SUBSEQUENT EVENT
In October 2001, Southern Financial completed a public offering of 862,500
shares of its common stock at $20.50 per share. The underwriting discount was
$1.435 per share, and the proceeds to Southern Financial were $16,143,563 net of
approximately $300,000 in expenses. The proceeds will be used to support the
growth of Southern Financial Bank, including, among other things, the opening of
de novo branches in Georgetown and Charlottesville, Virginia. In addition, a
portion of the proceeds is intended to support any further expansion and
potential acquisitions.
11
SOUTHERN FINANCIAL BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial Condition
- -------------------
Total assets of Southern Financial Bancorp, Inc. ("Southern Financial") at
September 30, 2001 increased to $749.4 million, a growth of 22.9 % compared with
December 31, 2000. The growth in total assets was primarily due to increases in
investment securities available-for-sale and loans receivable.
Total loans receivable increased 9.8% from $320.4 million at December 31,
2000, with the increase being in nonresidential mortgage and construction loans
and non-mortgage business loans. Since 1995, Southern Financial has steadily
increased the commercial loan portfolio, including nonresidential mortgage and
construction loans and non-mortgage business loans, consistent with its focus on
small to medium-sized business customers. The commercial real estate lending
program includes both loans closed under the Small Business Administration (SBA)
7(a) and 504 loan programs and loans closed outside of the SBA that serve both
the investor and owner occupied facility market. Southern Financial Bank's
lending philosophy and policy does not contemplate construction financing of
speculative commercial real estate projects.
Investment securities available-for-sale increased 45.0 % during the same
period. Southern Financial purchased investment securities totaling $388.1
million during the nine months ended September 30, 2001. The investment
securities purchased consisted primarily of fixed rate collateralized mortgage
obligations and corporate bonds. During the nine months ended September 30,
2001, Southern Financial sold investment securities available-for-sale for
proceeds totaling $142.5 million.
The growth in earning assets, as discussed above, was funded by deposits
and borrowings. The increase in advances from the FHLB totaling $21.5 million
consisted of overnight borrowings. Deposits increased 21.0% from $515.1 million
at December 31, 2000.
Results of Operations
- ---------------------
Southern Financial's principal sources of revenue are interest on loans,
gains on sales of loans and investment securities, fees and service charges on
loans, interest and dividends on investment securities, and service charges on
deposit accounts. Net income is affected by interest on deposits and borrowings
and operating expenses.
The following table presents, for periods indicated, average balances of and
weighted average yields on interest-earning assets and average balances of and
weighted average effective rates paid on interest-bearing liabilities.
Calculations have been made utilizing month-end average balances for loans and
investment securities and daily average balances for borrowings and deposits,
and the effect of the interest rate swaps is reflected in the average rate on
deposits. Loan balances do not include non-accrual loans.
12
Nine Months Ended September 30,
2001 2000
---------------------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
------------------- --------------------
($ in thousands)
Interest-earning assets
Loans receivable 344,365 8.98 250,576 9.53
Investments 302,118 7.22 155,313 6.98
------- ---- ------- ----
Total interest-earning assets 646,483 8.20 405,889 8.56
------- ---- ------- ----
Interest-bearing liabilities
Deposits 474,405 4.74 318,107 4.98
Borrowings 99,989 5.65 21,771 7.10
------- ---- ------- ----
Total interest-bearing liabilities 574,394 4.89 339,878 5.11
------- ---- ------- ----
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 72,089 66,011
======= =======
Interest rate spread 3.31 3.45
==== ====
Interest margin 3.85 4.28
==== ====
Non-interest bearing deposits 63,395 53,864
------- ---- ------- ----
Total deposits and borrowings 637,789 4.40 393,742 4.41
------- ---- ------- ----
Interest rate spread including
non-interest bearing deposits 3.80 4.15
==== ====
The following table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to changes in volume (changes in volume
multiplied by old rate) and changes in rate (changes in rate multiplied by old
volume). The dollar changes in interest income and interest expense
attributable to changes in rate/volume (change in rate multiplied by change in
volume) have been allocated between rate and volume variances based on the
percentage relationship of such variances to each other. The effect of the
interest rate swaps is reflected in interest expense on deposits.
For The Nine Months Ended
September 30, 2001
Versus
September 30, 2000
--------------------------------------
Volume Rate Net
------ ------- ------
($ in thousands)
Interest income
Loans receivable 6,325 (1,093) 5,232
Investments 8,121 296 8,417
------ ------- ------
Total interest income 14,446 (797) 13,649
------ ------- ------
Interest expense
Interest-bearing deposits 5,134 (171) 4,963
Borrowings 3,363 (283) 3,080
------ ------- ------
Total interest expense 8,497 (454) 8,043
------ ------- ------
Net interest income 5,949 (343) 5,606
====== ======= ======
13
Southern Financial's net income was $2.3 million for the three months ended
September 30, 2001, an increase of 76.9% over the $1.3 million earned during the
quarter ended September 30, 2000. Net income for the nine months ended September
30, 2001 was $6.0 million, an increase of 61.5% over the $3.7 million earned for
the same period last year.
Net interest income before provision for loan losses for the three months
ended September 30, 2001 was $7.2 million, an increase of 62.1% from $4.5
million for the three months ended September 30, 2000. The increase in net
interest income was primarily due to the growth in earning assets resulting from
purchases of investment securities, commecial loan originations, as well as the
acquisition of $71 million in First Savings Bank's assets in September 2000.
Average earning assets increased 64.9% to $719 million compared with the third
quarter of 2000. Deposits and borrowings, including $13 million of trust-
preferred securities issued in 2000, funded the earning asset growth. The net
interest margin was 4.03% for the quarter ended September 30, 2001, compared
with 4.10% for the quarter ended September 30, 2000, as Southern Financial
leveraged assets and increased the ratio of investment securities to loans
compared to the prior year. The net interest margin improved, however, compared
with the quarter ended June 30, 2001, from 3.86% to 4.03% due to a sharper
decline in Southern Financial's cost of funds versus the decline in yield on
earning assets. The cost of funds declined to 4.39% from 4.94% for the quarters
ended September 30 and June 30, 2001, respectively. Yield on earning assets only
declined to 7.95% from 8.20% for the same respective periods.
Net interest income before provision for loan losses for the nine months
ended September 30, 2001 was $18.7 million, an increase of 42.9%, from $13.1
million for the nine months ended September 30, 2000. The increase in net
interest income was due to the growth in earning assets resulting from purchases
of investment securities, increased commercial loan originations as well as the
acquisition of $71 million in First Savings Bank's assets in September 2000.
Average earning assets increased 59.3% to $646 million during the nine months
ended September 30, 2001, compared to the same period last year. The growth in
earning assets more than offset the decrease in the interest margin to 3.85%
during the nine months ended September 30, 2001, from 4.28% during the same
period last year, resulting in increased net interest income.
The provision for loan losses for the nine months ended September 30, 2001
was $2.4 million, as compared to $975 thousand for the nine months ended
September 30, 2000. The increase in the provision was driven by the growth in
the loan portfolio. Most of the loan portfolio increase was in the
nonresidential mortgage and construction loans, which are considered a higher
risk than the residential loans. Nonperforming loans have declined slightly
since December 31, 2000. Southern Financial continues to closely monitor the
loan portfolio, and makes charge-offs which it deems appropriate. Total charge-
offs were $1.7 million during the nine months ended September 30, 2001, as
compared to $527 thousand for the same period last year, which contributed to
the increase in the provision. The provision for loan losses is a current charge
to earnings to increase the allowance for loan losses. Southern Financial has
established the allowance for loan losses to absorb losses inherent in the loan
portfolio. Such allowance was established based on management's evaluation of
the loan portfolio, current economic conditions, changes in the nature and
volume of lending, past loan experience and other relevant factors. It is the
opinion of Southern Financial that the allowance for loan losses at September
30, 2001 remains adequate. Although Southern Financial believes that the
allowance is adequate, there can be no assurances that additions to such
allowance will not be necessary in future periods, which would adversely affect
the results of operations. The allowance for loan losses at September 30, 2001
was $6.0 million, or 1.70% of total loans receivable less deferred fees, versus
$4.9 million at December 31, 2000, which was 1.54% of total loans receivable
less deferred fees.
Other income for the nine months ended September 30, 2001 was $5.2 million,
an increase from $3.1 for the nine months ended September 30, 2000. During the
nine months ended September 30, 2001, Southern Financial sold $142.5 million of
fixed rate and adjustable rate investment securities and generated net gains of
$1.5 million. Investment securities totaling $29.8 million were sold during the
quarter ended September 30, 2001, and generated net gains of $363 thousand.
During the nine months ended September 30, 2001, gain on the sale of loans
decreased by $453 thousand compared to the same period last year. This occurred
because Southern Financial now retains the guaranteed portion of the SBA loans
it originates rather than selling it. In addition, income totaling $698 thousand
representing the increase in the current value of bank owned life insurance is
included in other income. Other income also includes the traditional deposit
fees, electronic banking fees, and fees generated from commercial service
products, all of which contributed to the increased non-interest income.
Other expense for the nine months ended September 30, 2001 was $12.7
million, an increase of 31.4% when compared to other expense for the same period
last year. Increased expenses resulting from the acquisition of First Savings
Bank, including goodwill amortization, accounted for a substantial portion of
the increase. Other expenses, including employee compensation, also increased
primarily due to normal pay increases and a larger employee base.
14
Regulatory Capital Requirements
- -------------------------------
At September 30, 2001 Southern Financial exceeded all regulatory capital
standards.
Liquidity
- ---------
The objective of Southern Financial's liquidity management is to assure the
ability to meet its financial obligations. These obligations include the payment
of deposits on demand or at maturity, the repayment of borrowings at maturity,
and the ability to fund loan commitments and other new business opportunities.
Liquidity is achieved by maintaining a core deposit base of demand and time
deposits, maintaining a portfolio of investment securities available for sale
and as collateral for borrowings, maintaining lines of credit at the Federal
Home Loan Bank of Atlanta equal to 25% of total assets or approximately $187
million, and access to capital markets. The use of derivative products such as
interest rate swaps enhances liquidity through the issuance of long-term
liabilities with limited interest rate risk exposure. Liquidity is also
enhanced by monitoring unfunded loan commitments, which reduces unexpected
funding requirements.
During the nine months ended September 30, 2001, Southern Financial has
funded its financial obligations with deposits, borrowings from the Federal Home
Loan Bank of Atlanta, and sales of investment securities. At September 30, 2001,
Southern Financial had $41.8 million of unfunded lines of credit and undisbursed
construction loan funds of $22.0 million. Approved loan commitments were $16.4
million at September 30, 2001. It is anticipated that funding requirements for
these commitments can be met from the normal sources of funds.
Recent Accounting Pronouncements
- --------------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and
Other Intangible Assets. Statement No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001.
Statement No. 142, which will become effective January 1, 2002, will require
that Southern Financial reassess the useful lives and residual values of all
intangible assets acquired in purchase business combinations, and make any
necessary amortization period or impairment loss adjustments by the end of the
first interim period after adoption. Statement No. 142 requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of Statement No. 142.
As of the date of adoption, Southern Financial expects to have unamortized
goodwill in the amount of $1.4 million and unamortized identifiable intangible
assets with definite lives in the amount of $1.9 million, all of which will be
subject to the transition provisions of Statements No. 141 and No. 142.
Amortization expense related to goodwill was $41 thousand and $78 thousand for
year ended December 31, 2000 and the nine months ended September 30, 2001,
respectively. Because of the extensive effort needed to comply with adopting
Statements No. 141 and No. 142, it is not practicable to reasonably estimate the
impact of adopting these Statements on Southern Financial's financial statements
at the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle.
In October 2001, FASB issued Statement No. 144, "Accounting for the
Impairment of Long-Lived Assets." Statement No. 144 supercedes Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" and the accounting and reporting provisions of APB No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business. Statement
No. 144 retains many of the provisions of Statement No. 121, but addresses
certain implementation issues associated with that statement. Statement No. 144
is effective for fiscal years beginning after December 15, 2001. This statement
is not expected to have a material impact on Southern Financial's financial
statements.
15
Special Note Regarding Forward-looking Information
- --------------------------------------------------
Certain statements under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and elsewhere in this
Quarterly Report and the documents incorporated herein by reference constitute
"forward-looking statements" within the meaning of the United States Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of Southern Financial, or
industry results, to be materially different from any future results,
performance, or achievements expressed or implied by such forward-looking
statements. Such factors include, among others, the following: general economic
and business conditions in Southern Financial's market area, inflation,
fluctuations in interest rates, changes in government regulations and
competition, which will, among other things, impact demand for loans and banking
services; the ability of Southern Financial to implement its business strategy;
and changes in, or the failure to comply with, government regulations.
Forward-looking statements are intended to apply only at the time they are
made. Moreover, whether or not stated in connection with a forward-looking
statement, Southern Financial undertakes no obligation to correct or update a
forward-looking statement should Southern Financial later become aware that it
is not likely to be achieved. If Southern Financial were to update or correct a
forward-looking statement, investors and others should not conclude that
Southern Financial would make additional updates or corrections thereafter.
Item 3 - Quantitative and Qualitative Disclosure about Market Risk
Southern Financial, like most other banks, is engaged primarily in the
business of investing funds obtained from deposits and borrowings into interest-
bearing loans and investments. Consequently, Southern Financial's earnings
depend to a significant extent on its net interest income, which is the
difference between (i) the interest income on loans and investments and (ii) the
interest expense on deposits and borrowing. Southern Financial, to the extent
that its interest-bearing liabilities do not reprice or mature at the same time
as its interest-bearing assets, is subject to interest rate risk and
corresponding fluctuations in its net interest income. Asset/liability
management policies have been employed in an effort to manage Southern
Financial's interest-earning assets and interest-bearing liabilities, thereby
controlling the volatility of net interest income, without having to incur
unacceptable levels of credit risk.
With respect to the residential mortgage loan portfolio, it is Southern
Financial's policy to keep in portfolio those mortgage loans which have an
adjustable interest rate and to sell most fixed rate mortgage loans originated
into the secondary market. In addition, commercial loans generally have rates
that are tied to the prime rate, the one-year CMT rate, or the three-year CMT
rate. Both of these policies help control Southern Financial's exposure to
rising interest rates.
Southern Financial's interest rate sensitivity is primarily monitored by
management through the use of a model which generates estimates of the change in
market value of portfolio equity ("MVPE") over a range of interest rate
scenarios. A third party prepared such analysis for Southern Financial. MVPE is
the present value of expected cash flows from assets, liabilities, and off-
balance sheet contracts using standard industry assumptions about estimated loan
prepayment rates, reinvestment rates, and deposit decay rates. The following
tables set forth an analysis of Southern Financial's interest rate risk as
measured by the estimated change in MVPE resulting from instantaneous and
sustained parallel shifts in the yield curve (plus or minus 300 basis points,
measured in 100 basis point increments) as of September 30, 2001 and December
31, 2000.
16
Sensitivity of Market Value of Portfolio Equity
As of September 30, 2001
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------------
Up 300 $ 34,023 (36,442) -51.72% 4.54% 71.52%
Up 200 49,828 (20,637) -29.29% 8.65% 104.74%
Up 100 66,467 (3,998) -5.67% 8.87% 139.71%
Base 70,465 - 0.00% 9.40% 148.12%
Down 100 68,274 (2,191) -3.11% 9.11% 143.51%
Down 200 74,510 4,045 5.74% 9.94% 156.62%
Down 300 79,350 8,885 12.62% 10.59% 166.79%
Sensitivity of Market Value of Portfolio Equity
As of December 31, 2000
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------------
Up 300 $ 35,488 (9,871) -21.76% 5.82% 89.42%
Up 200 40,706 (4,653) -10.26% 6.67% 102.56%
Up 100 42,502 (2,857) -6.30% 6.97% 107.09%
Base 45,359 - 0.00% 7.44% 114.29%
Down 100 47,492 2,133 4.70% 7.79% 119.66%
Down 200 48,809 3,450 7.61% 8.00% 122.98%
Down 300 50,867 5,508 12.14% 8.34% 128.16%
Beginning in the fourth quarter of 2000 Southern Financial undertook a
gradual restructuring of its portfolio in anticipation of a slowing U.S. economy
and a probable decline in interest rates. In the fourth quarter of 2000 Southern
Financial sold floating rate securities, incurring losses, and purchased fixed
rate securities. In the first and second quarters of 2001 Southern Financial
continued selling securities, taking gains, and purchased additional fixed rate
securities. When interest rates declined as expected in the first and second
quarters, the MVPE increased significantly. Southern Financial also became more
sensitive to both increases and decreases in interest rates. In the third
quarter, as interest rates continued to decline, the MVPE increased even
further; and this, combined with increases in the dealer estimates of prepayment
speeds, produced a smaller decline in the MVPE in the up 300 basis point
scenario. As a result, Southern Financial's interest rate risk profile has
returned to the more normal numbers that existed on December 31, 2000 and
earlier.
17
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurement. Modeling changes in MVPE requires the making of
certain assumptions that may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. Accordingly,
although the MVPE table provides an indication of Southern Financial's interest
rate risk exposure at a particular point in time, such measurement is not
intended to and does not provide a precise forecast of the effect of changes in
market interest rates on Southern Financial's worth.
18
SOUTHERN FINANCIAL BANCORP, INC.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
------------------
On October 18, 2001, Southern Financial settled a previously disclosed
lender liability suit with a former customer of the Bank. The terms of
the settlement had no material adverse effect on the consolidated
financial position or results of operations of Southern Financial.
Southern Financial is not a party to, nor is any of their property the
subject of, any other material pending legal proceedings incidental to
its business other than those arising in the ordinary course of
business. Although the amount of any ultimate liability with respect
to such matters cannot be determined, in the opinion of management,
any such liability will not have a material adverse effect on the
consolidated financial position or results of operations of Southern
Financial.
Item 2. CHANGES IN SECURITIES
---------------------
Not applicable
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
Not applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Not applicable
Item 5. OTHER INFORMATION
-----------------
Not applicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
---------------------------------
Exhibits Required
None
Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
September 30, 2001.
19
SOUTHERN FINANCIAL BANCORP, INC.
Part III. 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.
SOUTHERN FINANCIAL BANCORP, INC.
------------------------------------
(Registrant)
Date 11/14/01 /s/ Georgia S. Derrico
--------- ------------------------------------
Georgia S. Derrico
Chairman and
Chief Executive Officer
(Duly Authorized Representative)
Date 11/14/01 /s/ William H. Lagos
--------- ------------------------------------
William H. Lagos
Senior Vice President and Controller
Principal Accounting Officer
(Duly Authorized Representative)
20